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Financial Ratios

37 formulas

Financial-statement ratios decompose a company's balance sheet, income statement, cash flow statement, and operating dynamics into comparable, normalized metrics. Liquidity ratios measure short-term solvency; activity ratios measure operating efficiency; profitability ratios (margins, ROA, ROE, ROIC, ROCE, DuPont) measure how efficiently the firm generates returns; cash flow ratios assess the same questions using cash rather than accruals; leverage and solvency ratios measure capital structure and bankruptcy risk.

Liquidity

Current Ratio

Current assets divided by current liabilities. The standard short-term liquidity ratio: how many dollars of current assets cover each dollar of current liabilities.

CR=Current AssetsCurrent LiabilitiesCR = \frac{\text{Current Assets}}{\text{Current Liabilities}}

Quick Ratio (Acid-Test)

Current assets less inventory and other non-quick assets, divided by current liabilities. Other non-quick assets include prepayments and current assets that cannot readily settle near-term obligations.

Quick Ratio=Current Assets−Inventory−Other Non-Quick AssetsCurrent Liabilities\text{Quick Ratio} = \frac{\text{Current Assets} - \text{Inventory} - \text{Other Non-Quick Assets}}{\text{Current Liabilities}}

Cash Ratio

Cash and marketable securities divided by current liabilities. The strictest standard liquidity measure: pure cash on hand against near-term obligations.

CashR=Cash+Marketable SecuritiesCurrent LiabilitiesCashR = \frac{\text{Cash} + \text{Marketable Securities}}{\text{Current Liabilities}}

Working Capital

Current assets minus current liabilities. The dollar amount of liquid assets above what is needed for near-term obligations.

WC=Current Assets−Current LiabilitiesWC = \text{Current Assets} - \text{Current Liabilities}

Activity & Turnover

Inventory Turnover

Cost of goods sold divided by average inventory. Measures how many times inventory is sold and replaced over the year.

InvTurn=COGSAverage InventoryInvTurn = \frac{\text{COGS}}{\text{Average Inventory}}

Days Sales Outstanding (DSO)

Average number of days to collect receivables. Computed as average accounts receivable divided by daily sales (annual sales / 365).

DSO=Average ReceivablesSales/365DSO = \frac{\text{Average Receivables}}{\text{Sales} / 365}

Cash Conversion Cycle

Days inventory outstanding (DIO) plus days sales outstanding (DSO) minus days payable outstanding (DPO). The number of days between paying suppliers and collecting from customers.

CCC=DIO+DSO−DPOCCC = DIO + DSO - DPO

Days Inventory Outstanding (DIO)

Average number of days inventory is held before sale. Computed as average inventory divided by daily COGS.

DIO=Average InventoryCOGS/365DIO = \frac{\text{Average Inventory}}{\text{COGS} / 365}

Days Payable Outstanding (DPO)

Average number of days the firm takes to pay suppliers. Computed as average accounts payable divided by daily COGS.

DPO=Average PayablesCOGS/365DPO = \frac{\text{Average Payables}}{\text{COGS} / 365}

Receivables Turnover

Sales divided by average accounts receivable. Measures how many times receivables turn over per year — the annual-rate counterpart to DSO.

Receivables Turnover=SalesAverage Receivables\text{Receivables Turnover} = \frac{\text{Sales}}{\text{Average Receivables}}

Payables Turnover

COGS divided by average accounts payable. Measures how many times payables turn over per year — the annual-rate counterpart to DPO.

Payables Turnover=COGSAverage Payables\text{Payables Turnover} = \frac{\text{COGS}}{\text{Average Payables}}

Profitability

Gross Profit Margin

Gross profit (revenue minus cost of goods sold) divided by revenue. Measures pricing power and direct-cost efficiency before any operating, financing, or tax effects.

Gross Margin=Revenue−COGSRevenue\text{Gross Margin} = \frac{\text{Revenue} - \text{COGS}}{\text{Revenue}}

Operating Margin

Operating income (EBIT) divided by revenue. Captures profitability from core operations after all operating costs but before interest and taxes.

Operating Margin=EBITRevenue\text{Operating Margin} = \frac{EBIT}{\text{Revenue}}

Net Profit Margin

Net income divided by revenue. The bottom-line profitability ratio, after every operating, financing, and tax effect.

Net Margin=Net IncomeRevenue\text{Net Margin} = \frac{\text{Net Income}}{\text{Revenue}}

EBITDA Margin

EBITDA (earnings before interest, taxes, depreciation, and amortization) divided by revenue. Operating profitability with non-cash D&A added back.

EBITDA Margin=EBITDARevenue\text{EBITDA Margin} = \frac{\text{EBITDA}}{\text{Revenue}}

Effective Tax Rate

Income tax expense divided by pretax income for the same reporting period. This is an accrual accounting tax rate, not necessarily the cash tax paid rate.

Effective Tax Rate=Tax ExpensePretax Income\text{Effective Tax Rate} = \frac{\text{Tax Expense}}{\text{Pretax Income}}

Return on Assets (ROA)

Net income divided by average total assets over the reporting period. Because net income includes financing costs, this version of ROA is affected by capital structure.

ROA=Net IncomeTotal Assets\text{ROA} = \frac{\text{Net Income}}{\text{Total Assets}}

Return on Equity (ROE)

Net income divided by shareholders' equity. Measures the return generated on book equity — the most cited single profitability metric for equities.

ROE=Net IncomeEquity\text{ROE} = \frac{\text{Net Income}}{\text{Equity}}

Return on Invested Capital (ROIC)

NOPAT (net operating profit after tax) divided by invested capital (equity + interest-bearing debt − cash). Capital-structure-neutral profitability metric — measures how efficiently the entire enterprise generates returns.

ROIC=NOPATInvested Capital\text{ROIC} = \frac{\text{NOPAT}}{\text{Invested Capital}}

Return on Capital Employed (ROCE)

EBIT divided by capital employed (total assets − current liabilities, equivalent to equity + non-current liabilities). Pre-tax operating return on the long-term capital base.

ROCE=EBITCapital Employed=EBITTotal Assets−Current Liabilities\text{ROCE} = \frac{EBIT}{\text{Capital Employed}} = \frac{EBIT}{\text{Total Assets} - \text{Current Liabilities}}

DuPont Decomposition

Three-factor decomposition of ROE: net margin × asset turnover × equity multiplier. Identifies the source of a company's ROE — operating profitability, asset efficiency, or financial leverage.

ROE=Net Margin×Asset Turnover×Equity Multiplier\text{ROE} = \text{Net Margin} \times \text{Asset Turnover} \times \text{Equity Multiplier}

Cash Flow

Free Cash Flow

Operating cash flow minus total cash capital expenditures over the same period. This simple measure does not deduct every financing obligation or define distributable cash by itself.

FCF=CFO−CapExFCF = CFO - CapEx

Operating Cash Flow Margin

Cash from operations divided by revenue. The cash-based counterpart to net profit margin — measures how much actual cash is generated per dollar of sales.

OCF Margin=CFORevenue\text{OCF Margin} = \frac{CFO}{\text{Revenue}}

Operating Cash Flow Ratio

Cash from operations divided by current liabilities. Cash-based liquidity measure — how many times annual operating cash flow could cover near-term obligations.

OCF Ratio=CFOCurrent Liabilities\text{OCF Ratio} = \frac{CFO}{\text{Current Liabilities}}

Cash Coverage Ratio

Cash interest coverage using CFO after cash interest and cash income taxes: (CFO + cash interest paid + cash taxes paid) / cash interest paid.

Cash Coverage=CFO+Cash Interest Paid+Cash Taxes PaidCash Interest Paid\text{Cash Coverage} = \frac{CFO + \text{Cash Interest Paid} + \text{Cash Taxes Paid}}{\text{Cash Interest Paid}}

Cash Flow to Debt

Cash from operations divided by total interest-bearing debt. Approximate measure of how many years of operating cash flow would be required to pay off all debt.

CFO/Debt=CFOTotal Debt\text{CFO/Debt} = \frac{CFO}{\text{Total Debt}}

Free Cash Flow Margin

Free cash flow (operating cash flow less capital expenditures) as a fraction of revenue: the share of each sales dollar that ends up as cash the company can distribute or reinvest.

FCF Margin=CFO−CapExRevenue\text{FCF Margin} = \frac{\text{CFO} - \text{CapEx}}{\text{Revenue}}

Leverage & Solvency

Debt-to-Equity Ratio

Total interest-bearing debt divided by shareholders' equity. The most commonly cited capital-structure ratio.

D/E=Total DebtShareholders’ EquityD/E = \frac{\text{Total Debt}}{\text{Shareholders' Equity}}

Debt-to-Assets Ratio

Total interest-bearing debt divided by total assets. The fraction of assets financed by debt.

D/A=Total DebtTotal AssetsD/A = \frac{\text{Total Debt}}{\text{Total Assets}}

Interest Coverage Ratio

Earnings before interest and taxes (EBIT) divided by interest expense. Sometimes called Times Interest Earned (TIE). Measures how many times operating earnings cover the firm's interest obligations.

IC=EBITInterest ExpenseIC = \frac{EBIT}{\text{Interest Expense}}

Degree of Operating Leverage (DOL)

Contribution margin (sales − variable costs) divided by EBIT. Measures how sensitively EBIT moves to a percentage change in sales.

DOL=Contribution MarginEBIT=Sales−Variable CostsEBITDOL = \frac{\text{Contribution Margin}}{EBIT} = \frac{\text{Sales} - \text{Variable Costs}}{EBIT}

Degree of Financial Leverage (DFL)

EBIT divided by EBT (earnings before tax = EBIT − interest). Measures how sensitively pre-tax earnings (and hence EPS) move to a percentage change in EBIT.

DFL=EBITEBIT−InterestDFL = \frac{EBIT}{EBIT - \text{Interest}}

Altman Z-Score

A weighted combination of five financial ratios designed to predict bankruptcy risk for public manufacturers. Originally developed by Edward Altman in 1968 and remarkably durable as a distress indicator.

Z=1.2⋅WCTA+1.4⋅RETA+3.3⋅EBITTA+0.6⋅METL+1.0⋅SalesTAZ = 1.2 \cdot \frac{WC}{TA} + 1.4 \cdot \frac{RE}{TA} + 3.3 \cdot \frac{EBIT}{TA} + 0.6 \cdot \frac{ME}{TL} + 1.0 \cdot \frac{Sales}{TA}

Net Debt

Interest-bearing debt less cash and marketable securities: what the company would still owe if it used all its cash to repay lenders. Negative net debt means a net cash position.

Net Debt=Total Debt−Cash\text{Net Debt} = \text{Total Debt} - \text{Cash}

Net Debt to EBITDA

Net debt divided by EBITDA: roughly how many years of operating cash earnings it would take to repay the debt net of cash. The most common leverage covenant in loan agreements and credit analysis.

Net DebtEBITDA=Total Debt−CashEBITDA\frac{\text{Net Debt}}{\text{EBITDA}} = \frac{\text{Total Debt} - \text{Cash}}{\text{EBITDA}}

Degree of Combined Leverage

Operating leverage times financial leverage: the percentage change in earnings per share for a one percent change in sales. Fixed operating costs amplify sales into operating income; fixed interest amplifies operating income into net income; this captures both at once.

DTL=DOL×DFL=%ΔEPS%ΔSalesDTL = DOL \times DFL = \frac{\% \Delta EPS}{\% \Delta \text{Sales}}