5 Financial Key Ratios - Calculation and Interpretation | maijson GKB.

The Current Ratio assesses liquidity by comparing current assets to liabilities, whereas the Quick Ratio applies a more stringent test that excludes inventories. Return on Equity (ROE) measures profitability from shareholder equity. The Debt-to-Equity Ratio measures financial leverage and risk, while the Gross Profit Margin indicates how effectively a corporation earns profit after production costs. These ratios measure financial health and performance.

 

Profitability Ratios

·         Gross Profitability Ratio:

Formula (Gross Profit / Net Sales) x 100

Example A company with gross profit of $500,000 and sales of $1,000,000 has a gross margin of 50%.

·         Net profit margin:

Formula (Net Profit / Net Sales) x 100

Example If a business generates a net profit of $200,000 on revenues of $800,000, the net profit margin would be 25%.

 

Liquidity Ratio

·         Current ratio:

Formula Current assets / Current liabilities

Example A company with current assets of $600,000 and current liabilities of $300,000 has a current ratio of 2.

·         Liquid ratio:

Formula (Current Assets - Inventories) / Current Liabilities

Example: If a company has current assets of $500,000, inventories of $100,000, and current liabilities of $200,000, the current ratio is 2.

 

Efficiency ratios

·         Inventory turnover ratio:

Formula Cost of sales divided by average inventory

Example: If cost of sales is $1,000,000 and average inventory is $200,000, the inventory turnover ratio is 5.

·         Days Sales Outstanding (DSO):

Formula (Accounts Receivable / Total Credit Sales) * Number of Days

Example: If accounts receivable of $50,000, total credit sales of $500,000, and collection period of 30 days, DSO is 6 days.

·         Inventory turnover ratio:

Formula Cost of Sales / Average Inventory

Example: If a company's cost of sales is $500,000 and average inventory is $100,000, inventory turnover is 5.

·         Accounts Receivable Turnover:

Formula Net Sales / Average Accounts Receivable

Example: If net credit sales are $800,000 and average accounts receivable are $200,000, the accounts receivable turnover ratio is 4.

 

Solvency Ratios

·         Debt-to-equity ratio:

Formula Liabilities / Shareholders' Equity

Example: If a company has liabilities of $800,000 and shareholders' equity of $1,200,000, the debt-to-equity ratio would be 0.67.

·         Interest coverage ratio:

Formula Earnings before interest and taxes (EBIT) / Interest expense

Example: If EBIT is $500,000 and interest expense is $100,000, the interest coverage ratio is 5.

 

Market Ratio

·         Price-to-earnings ratio (PER):

Formula Market price per share / Earnings per share (EPS)

Example: If the market price per share is $40 and EPS is $4, the PER is 10.

·         Dividend Yield:

Formula Dividend per share ÷ Market price per share

Example If a company pays a dividend of $2 per share and the market price per share is $50, the dividend yield is 4%.

·         Current ratio:

Formula Current Assets / Current Liabilities

Example: Current assets of $800,000 and current liabilities of $400,000 would result in a current ratio of 2.

·         Quick Ratio (Acid-Test Ratio):

Formula (Current Assets - Inventories) / Current Liabilities

Example: If current assets excluding inventory are $600,000 and current liabilities are $200,000, the quick ratio is 3. Profitability Ratio

·         Net profit margin:

Formula (Net Profit / Net Sales) x 100

Example: If net income is $150,000 on sales of $1 million, the net profit margin is 15%.

·         Return on Equity (ROE):

Formula Net income / Average shareholders' equity

Example: If net income is $200,000 and average shareholders' equity is $1,000,000, ROE is 20%.

 

Conclusion: These ratios are just the tip of the iceberg, and mastering their interpretation will enable you to make informed decisions in the dynamic world of finance. There are many other ratios that provide a comprehensive view of a company's financial health. The key is to use a combination of ratios to gain a comprehensive understanding of the various aspects of performance and risk.

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