Financial Ratio Formula with Interpretation

ratio

Important Financial Ratio Formula with Interpretation

Current Ratio FormulaCurrent Assets/Current LiabilitiesInterpretation: Current Ratio Measures Liquidity i.e companies ability to pay its current liabilities out of its current assets. How many current assets are their for each current liability for example Current Ratio of 2:1 means company has two times of current assets against its current liabilities.
Quick Ratio FormulaLiquid Assets/Current Liability

liquid assets = current assets - (inventory + prepaid expenses)

Interpretation: Quick ratio also called as Acid Test Ratio measures companies ability to meet its current obligations arising from current liabilities through quick assets (which can be encashed during the year). Which can be cash or cash generating assets in short period of time.

EPS Formula

Net Income - Preferred Dividends / Weighted Average Shares OutstandingInterpretation: This is used to understand fair value of the company. For example if the market price per share is less than its book value per share, the company can be said as undervalued. But we also need to understand the
Gross Profit Margin Ratio FormulaGross Profit/Net Sales X 100Interpretation: Gross Profit Margin ratio tells the companies profit margin percentage. This is calculated before Tax, Depreciation, Amortisation.
Operating Expenses Ratio FormulaOperating Expenses/Net Sales X 100Interpretation: Operating cost is the sum of cost of goods sold + operating expenses. Non-operating expenses like interest, loan repayment instalments and taxes etc. are not added as for the computation. Lower Operating cost result in higher Net Profits.
Operating Profit ratio FormulaOperating Profit/Net Sales X 100Interpretation: Operating Profit ratio calculates the profit margin the company makes after covering its operating expenses. Higher the ratio is better.
Net Profit (NP) Ratio FormulaNet Profit After Tax/Net Sales X 100Interpretation: Net Profit Ratio used to evaluate net business margin the company generates from its core business activity or from its operations. Net sale are therefore considered and items like extraordinary income or one time income from sale of fixed assets or income from investment are excluded. Which gives a clear picture as to how companies operations are able to generate net profit out of its operations activity as percentage of net sales.
Return on Investment Ratio (ROI) FormulaNet Profit After Interest & Taxes/ Shareholders Funds or Investments  X 100Interpretation: This is most used ratio to understand ROI on each investment or total investment made by the company and the return assets are fetching YoY. This shows the rate of return on investment this can be effectively used even to examine each assets created and amount invested in each assets and its revenue generated year on year. Higher the ROI greater the benefits.
Return on Capital Employed Ratio (ROCE) FormulaNet Profit after Taxes/ Gross Capital Employed X 100Interpretation: ROCE or return on capital employed ratio shows investors ability of the company to generate return out of the investment made. In simple terms it shows how much dollar revenue is made for each dollar invested. Higher the rate of return is better.
Earnings Per Share Ratio Formula
Net Profit After Tax & Preference Dividend / Average no of common Equity SharesInterpretation: This ratio gives clear direction to investors as to how much earnings each share invested makes in a year. This calculates earnings per share against net income - dividend paid to preferential shareholders, which is essentially left to equity shareholders as value created per share.
Dividend Payout Ratio FormulaDividend Per Equity Share/Earning Per Equity Share X 100Interpretation: This ratio help investors understand how much dividend each share held can be paid back to the equity investors out of earnings made per year. And how much is retained as reserve for future expansion of the operations. Steady dividend payout ratio is favourable. Sometimes when company makes abnormal huge profits to maintain final yearly dividend steady companies often announce bonus shares or mid term dividends.
Inventory Turnover Ratio FormulaInventory Turnover Ratio = Cost of Goods Sold / Average InventoryInterpretation: Inventory Turnover ratio help understand companies ability in keeping its manufacturing cost steady and cost effective. There are various implications when analysing this important ratio like method used for inventory LIFO, FIFO etc.. You can read detailed analysis of Inventory Turnover ratio in our ratio analysis section.
Debtors / Receivables Turnover Ratio FormulaNet Credit Sales /  Average Account ReceivablesInterpretation: Also termed as activity ratio, this shows how fast the company recovers its credit sales in a given year. In other words it shows number of days company takes to recover its debtors. Less the number of days is favourable. Which will result in less working capital requirements.
Creditors Turnover Ratio FormulaNet Credit Purchases / Average Accounts PayableInterpretation: This ratio help creditos evaluate how fast company is able to pay its bills or credit purchases. Average time company takes to pay off its creditors less the days it takes to pay bills is considered to be favourable among suppliers. Which in turn shows high operations ability of the management and robust operating cycle.
Working Capital Turnover Ratio FormulaNet Sales / Average Working CapitalInterpretation: Working capital turnover ratio is a activity ratio which shows companies ability to utilize its working capital to generate revenues. Higher the ratio means more sales being done with said working capital, hence companies working capital requirement are efficient and don't heavily dependent on access working capital to run the business.
Fixed Assets Turnover Ratio FormulaCost of goods Sold / Total Fixed AssetsInterpretation: Fixed assets turnover ratio calculates number of times revenue generated against its fixed assets. Or revenue generated for per dollar of investment made in fixed assets. Higher the ratio is better and shows investment made in fixed assets have higher yield.
Interest Coverage Ratio Formula
Earnings Before Interest and Tax (EBIT) / Interest ExpensesInterpretation: Interest Coverage ratio measures a company’s ability to make timely interest payments on its debt. More number of times the EBIT against its interest due is considered healthy and company is eligible for further lending.

 

Download DW App: Learning Delight

Author: dwapp