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A financial ratio or accounting ratio is a relative magnitude of two selected numerical values taken from an enterprise's
financial statement Financial statements (or financial reports) are formal records of the financial activities and position of a business, person, or other entity. Relevant financial information is presented in a structured manner and in a form which is easy to un ...
s. Often used in
accounting Accounting or Accountancy is the measurement ' Measurement is the number, numerical quantification (science), quantification of the variable and attribute (research), attributes of an object or event, which can be used to compare with other ob ...
, there are many standard
ratio In mathematics, a ratio indicates how many times one number contains another. For example, if there are eight oranges and six lemons in a bowl of fruit, then the ratio of oranges to lemons is eight to six (that is, 8∶6, which is equivalent to ...

ratio
s used to try to evaluate the overall financial condition of a corporation or other organization. Financial ratios may be used by managers within a firm, by current and potential
shareholder A shareholder (in the United States often referred to as stockholder) of a corporation is an individual or legal entity (such as another corporation, a body politic, a Trust law, trust or partnership) that is registered by the corporation as the ...
s (owners) of a firm, and by a firm's
creditor A creditor or lender is a party 300px, '' Hip, Hip, Hurrah!'' (1888) by Peder Severin Krøyer, a painting portraying an artists' party in 19th century Denmark A party is a gathering of people who have been invited by a host A host is ...

creditor
s.
Financial analyst A financial analyst is a professional, undertaking financial analysis Financial analysis (also referred to as financial statement analysis or accounting analysis or Analysis of finance) refers to an assessment of the viability, stability, and prof ...
s use financial ratios to compare the strengths and weaknesses in various companies. If shares in a company are traded in a
financial market A financial market is a market (economics), market in which people trade financial Security (finance), securities and derivative (finance), derivatives at low transaction costs. Some of the securities include stocks and Bond (finance), bonds, ra ...
, the market price of the shares is used in certain financial ratios. Ratios can be expressed as a
decimal value
decimal value
, such as 0.10, or given as an equivalent
percent In mathematics Mathematics (from Greek: ) includes the study of such topics as numbers (arithmetic and number theory), formulas and related structures (algebra), shapes and spaces in which they are contained (geometry), and quantities a ...

percent
value, such as 10%. Some ratios are usually quoted as percentages, especially ratios that are usually or always less than 1, such as
earnings yield Earning yield is the quotient of earnings per share (E), divided by the share price (P), giving E/P. It is the reciprocal of the P/E ratio. The earning yield is quoted as a percentage, and therefore allows immediate comparison to prevailing long-t ...
, while others are usually quoted as decimal numbers, especially ratios that are usually more than 1, such as P/E ratio; these latter are also called multiples. Given any ratio, one can take its
reciprocal Reciprocal may refer to: In mathematics * Multiplicative inverse, in mathematics, the number 1/''x'', which multiplied by ''x'' gives the product 1, also known as a ''reciprocal'' * Reciprocal polynomial, a polynomial obtained from another poly ...
; if the ratio was above 1, the reciprocal will be below 1, and conversely. The reciprocal expresses the same information, but may be more understandable: for instance, the earnings yield can be compared with bond yields, while the P/E ratio cannot be: for example, a P/E ratio of 20 corresponds to an earnings yield of 5%.


Sources of data

Values used in calculating financial ratios are taken from the
balance sheet In financial accounting Financial accounting is the field of accounting Accounting or Accountancy is the measurement, processing, and communication of financial and non financial information about economic entity, economic entities such ...

balance sheet
,
income statement An income statement or profit and loss accountProfessional English in Use - Finance, Cambridge University Press, p. 10 (also referred to as a ''profit and loss statement'' (P&L), ''statement of profit or loss'', ''revenue statement'', ''statemen ...
,
statement of cash flows In financial accounting Financial accounting is the field of accounting Accounting or Accountancy is the measurement, processing, and communication of financial and non financial information about economic entity, economic entities such as b ...
or (sometimes) the
statement of changes in equity A statement of changes in equity and similarly the statement of changes in owner's equity for a , statement of changes in partners' equity for a , statement of changes in shareholders' equity for a or statement of changes in taxpayers' equity for ...
. These comprise the firm's "accounting statements" or
financial statements Financial statements (or financial reports) are formal records of the financial activities and position of a business, person, or other entity. Relevant financial information is presented in a structured manner and in a form which is easy to un ...
. The statements' data is based on the accounting method and accounting standards used by the organisation.


Purpose and types

Financial ratios quantify many aspects of a business and are an integral part of the
financial statement analysis Financial statement analysis (or financial analysis) is the process of reviewing and analyzing a company's financial statement Financial statements (or financial reports) are formal records of the financial activities and position of a business ...
. Financial ratios are categorized according to the financial aspect of the business which the ratio measures. Liquidity ratios measure the availability of cash to pay debt. Activity ratios measure how quickly a firm converts non-cash assets to cash assets.Groppelli, p. 436.
Debt ratio Debt Ratio is a financial ratio A financial ratio or accounting ratio is a relative magnitude of two selected numerical values taken from an enterprise's financial statement Financial statements (or financial reports) are formal records of the ...
s measure the firm's ability to repay long-term debt.Groppelli, p. 439. Profitability ratios measure the firm's use of its assets and control of its expenses to generate an acceptable rate of return. Market ratios measure investor response to owning a company's stock and also the cost of issuing stock.Groppelli, p. 445. These are concerned with the return on investment for
shareholder A shareholder (in the United States often referred to as stockholder) of a corporation is an individual or legal entity (such as another corporation, a body politic, a Trust law, trust or partnership) that is registered by the corporation as the ...
s, and with the relationship between return and the value of an investment in company's shares. Financial ratios allow for comparisons * between companies * between industries * between different time periods for one company * between a single company and its industry average Ratios generally are not useful unless they are
benchmarked
benchmarked
against something else, like past performance or another company. Thus, the ratios of firms in different industries, which face different risks, capital requirements, and competition are usually hard to compare.


Accounting methods and principles

Financial ratios may not be directly comparable between companies that use different
accounting methods A basis of accounting is the time various financial transactions are recorded. The cash basis (EU VAT vocabulary ''cash accounting'') and the accrual basisAccrual (''accumulation'') of something is, in finance, the adding together of interest or ...
or follow various
standard accounting practice Publicly traded companies typically are subject to the most rigorous standards. Small and midsized businesses often follow more simplified standards, plus any specific disclosures required by their specific lenders and shareholders. Some firms oper ...
s. Most
public companies A public company, publicly traded company, publicly held company, publicly listed company, or public limited company is a company A company, abbreviated as co., is a legal entity In law, a legal person is any person A person (plura ...
are required by law to use
generally accepted accounting principles Publicly traded companies typically are subject to the most rigorous standards. Small and midsized businesses often follow more simplified standards, plus any specific disclosures required by their specific lenders and shareholders. Some firms oper ...
for their home countries, but
private companies A privately held company, private company, or close corporation is a corporation not owned by the government, non-governmental organizations and by a relatively small number of shareholders or company members, which does not offer or trade its com ...
,
partnership A partnership is an arrangement where parties, known as business partner A business partner is a commercial entity with which another commercial entity has some form of Business alliance, alliance. This relationship may be a contractual, exclus ...

partnership
s and
sole proprietorship A sole proprietorship , also known as a sole tradership, individual entrepreneurship or proprietorship, is a type of enterprise owned and run by one person and in which there is no legal distinction between the owner and the business entity I ...
s may elect to not use accrual basis accounting. Large multi-national corporations may use
International Financial Reporting Standards International Financial Reporting Standards, commonly called IFRS, are accounting standard Publicly traded companies typically are subject to the most rigorous standards. Small and midsized businesses often follow more simplified standards, plus ...
to produce their financial statements, or they may use the generally accepted accounting principles of their home country. There is no international standard for calculating the summary data presented in all financial statements, and the terminology is not always consistent between companies, industries, countries and time periods.


Abbreviations and terminology

Various abbreviations may be used in financial statements, especially financial statements summarized on the
Internet The Internet (or internet) is the global system of interconnected computer networks that uses the Internet protocol suite (TCP/IP) to communicate between networks and devices. It is a ''internetworking, network of networks'' that consist ...

Internet
.
Sales Sales are activities related to selling or the number of goods sold in a given targeted time period. The delivery of a service for a cost is also considered a sale. The seller, or the provider of the goods or services, completes a sale in ...
reported by a firm are usually
net sales Net or net may refer to: Mathematics and physics * Net (mathematics) In mathematics Mathematics (from Greek: ) includes the study of such topics as numbers ( and ), formulas and related structures (), shapes and spaces in which they ...
, which deduct returns, allowances, and early payment discounts from the charge on an
invoice An invoice, bill or tab is a commercial Commercial may refer to: * a dose of advertising conveyed through media (such as - for example - radio or television) ** Radio advertisement ** Television advertisement * (adjective for:) commerce, a sys ...

invoice
.
Net income In business Business is the activity of making one's living or making money by producing or buying and selling products (such as goods and services). Simply put, it is "any activity or enterprise entered into for profit." Having a busin ...
is always the amount ''after'' taxes, depreciation, amortization, and interest, unless otherwise stated. Otherwise, the amount would be EBIT, or EBITDA (see below). Companies that are primarily involved in providing services with labour do not generally report "Sales" based on hours. These companies tend to report "revenue" based on the monetary value of income that the services provide. Note that Shareholders' Equity and Owner's Equity are ''not'' the same thing, Shareholder's Equity represents the total number of shares in the company multiplied by each share's book value; Owner's Equity represents the total number of shares that an individual shareholder owns (usually the owner with
controlling interest A controlling interest is an ownership interest in a corporation with enough voting stock In finance, stock (also capital stock) consists of all of the shares In financial markets A financial market is a market in which people trad ...
), multiplied by each share's book value. It is important to make this distinction when calculating ratios.


Abbreviations

(''Note: '' These are not ratios, but values in currency.) * COGS = Cost of goods sold, or cost of sales. * EBIT =
Earnings Earnings are the net benefits of a corporation A corporation is an organization—usually a group of people or a company—authorized by the State (polity), state to act as a single entity (a legal entity recognized by private and public law ...
before
interest In finance Finance is the study of financial institutions, financial markets and how they operate within the financial system. It is concerned with the creation and management of money and investments. Savers and investors have money availa ...

interest
and
taxes A tax is a compulsory financial charge or some other type of levy imposed on a taxpayer (an individual or legal entity In law Law is a system A system is a group of Interaction, interacting or interrelated elements that act accord ...

taxes
*
EBITDA A company A company, abbreviated as co., is a Legal personality, legal entity representing an association of people, whether Natural person, natural, Legal person, legal or a mixture of both, with a specific objective. Company members sha ...
= Earnings before interest, taxes,
depreciation In accountancy, depreciation refers to two aspects of the same concept: first, the actual decrease of fair value of an asset, such as the decrease in value of factory equipment each year as it is used and wear, and second, the allocation in a ...

depreciation
, and
amortization Amortization (or amortisation; ) is paying off an amount owed over time by making planned, incremental payments of principal Principal may refer to: Title or rank * Principal (academia) The principal is the chief executive and the chief academ ...
*
EPS
EPS
= Earnings per share


Ratios


Profitability ratios

Profitability ratios measure the company's use of its assets and control of its expenses to generate an acceptable rate of return :;
Gross margin Gross margin is the difference between revenue In accounting Accounting or Accountancy is the measurement ' Measurement is the number, numerical quantification (science), quantification of the variable and attribute (research), attributes ...
, Gross profit margin or Gross Profit RateWilliams, p. 1094. :::\frac :::OR :::\frac ---- :;
Operating margin In business Business is the activity of making one's living or making money by producing or buying and selling products (such as goods and services). Simply put, it is "any activity or enterprise entered into for profit." Having a business n ...
, Operating Income Margin, Operating profit margin or Return on sales (ROS) :::\frac :Note: Operating income is the difference between operating revenues and operating expenses, but it is also sometimes used as a synonym for EBIT and operating profit. This is true if the firm has no non-operating income. (
Earnings before interest and taxes In accounting Accounting or Accountancy is the measurement ' Measurement is the number, numerical quantification (science), quantification of the variable and attribute (research), attributes of an object or event, which can be used to comp ...
/ Sales) ---- :;
Profit margin Profit margin, net margin, net profit margin or net profit ratio is a measure of profitability An economic profit is the difference between the revenue a has received from its outputs and the s of its inputs. Unlike an , an economic profit ta ...
, net margin or net profit marginGroppelli, p. 444. :::\frac ---- :;
Return on equity The return on equity (ROE) is a measure of the profitability of a business in relation to the equity Equity may refer to: Finance, accounting and ownership *Equity (finance), ownership of assets that have liabilities attached to them ** Stock, e ...
(ROE) :::\frac ---- :;
Return on assets The return on assets (ROA) shows the percentage of how profitable An economic profit is the difference between the revenue a commerce , commercial entity has received from its outputs and the opportunity costs of its inputs. Unlike an accountin ...
(ROA ratio or Du Pont Ratio) :::\frac ---- :;
Return on assets The return on assets (ROA) shows the percentage of how profitable An economic profit is the difference between the revenue a commerce , commercial entity has received from its outputs and the opportunity costs of its inputs. Unlike an accountin ...
(ROA) :::\frac ---- :; Return on assets Du Pont (ROA Du Pont) :::\left(\frac\right)\left(\frac\right) ---- :; Return on Equity Du Pont (ROE Du Pont) :::\left(\frac\right)\left(\frac\right)\left(\frac\right) ---- :;
Return on net assets The return on net assets (RONA) is a measure of financial performance of a company which takes the use of assets into account. Higher RONA means that the company is using its assets and working capital efficiently and effectively. RONA is used by in ...
(RONA) :::\frac ---- :;
Return on capital Return on capital (ROC), or return on invested capital (ROIC), is a ratio used in finance Finance is a term for the management, creation, and study of money In a 1786 James Gillray caricature, the plentiful money bags handed to King Geor ...
(ROC) :::\frac ---- :; Risk adjusted return on capital (RAROC) :::\frac :::OR :::\frac ---- :;
Return on capital employed Return on capital employed is an accounting ratio used in finance, valuation, and accounting. It is a useful measure for comparing the relative profitability of companies after taking into account the amount of capital used.Fernandes, Nuno. Finance ...
(ROCE) :::\frac :::Note: this is somewhat similar to (ROI), which calculates Net Income per Owner's Equity ---- :;
Cash flow return on investment Cash-flow return on investment (CFROI) is a Valuation (finance), valuation model that assumes the stock market sets prices based on cash flow, not on corporate performance and earnings. :\text = \frac For the corporation, it is essentially inter ...
(CFROI) :::\frac ---- :;
Efficiency ratio The efficiency ratio indicates the expenses as a percentage of revenue (expenses / revenue), with a few variations – it is essentially how much a corporation or individual spends to make a dollar; entities are supposed to attempt minimizing effic ...
:::\frac ---- :;Net gearing :::\frac ---- :;Basic Earnings Power Ratio :::\frac ---- ----


Liquidity ratios

Liquidity Liquidity is a concept in economics involving the convertibility of assets and obligations. It can include: * Market liquidity In business, economics or investment, market liquidity is a market's feature whereby an individual or firm can qui ...
ratios measure the availability of cash to pay debt. :; Current ratio (Working Capital Ratio)Groppelli, p. 435. :::\frac ---- :; Acid-test ratio (Quick ratio) :::\frac ---- :; Cash ratio :::\frac ---- :;
Operating cash flow In financial accounting Financial accounting is the field of accounting Accounting or Accountancy is the measurement, processing, and communication of financial and non financial information about economic entity, economic entities such as ...
ratio :::\frac ----


Activity ratios (Efficiency Ratios)

Activity ratios measure the effectiveness of the firm's use of resources. :; Average collection period :::\frac :; Degree of Operating Leverage (DOL) :::\frac :; DSO Ratio. :::\frac :;Average payment period :::\frac :;
Asset turnoverAsset turnover (ATO), total asset turnover, or asset turns is a financial ratio that measures the efficiency of a company's use of its assets in generating sales revenue or sales income to the company. Asset turnover is considered to be an Activity R ...
:::\frac :; Stock turnover ratio :::\frac :; Receivables Turnover Ratio :::\frac :;Inventory conversion ratio :::\frac :;Inventory conversion period (essentially same thing as above) :::\left (\frac\right)\mbox :;Receivables conversion period :::\left (\frac\right)\mbox :;Payables conversion period :::\left (\frac\right)\mbox :;
Cash Conversion Cycle In management accounting In management accounting or managerial accounting, managers use accounting Accounting or Accountancy is the measurement, processing, and communication of financial and non financial information about economic entity ...
:::\mbox


Debt ratios (leveraging ratios)

Debt ratios quantify the firm's ability to repay long-term debt. Debt ratios measure
financial leverage In finance Finance is a term for the management, creation, and study of money In a 1786 James Gillray caricature, the plentiful money bags handed to King George III are contrasted with the beggar whose legs and arms were amputated, in t ...
. :;
Debt ratio Debt Ratio is a financial ratio A financial ratio or accounting ratio is a relative magnitude of two selected numerical values taken from an enterprise's financial statement Financial statements (or financial reports) are formal records of the ...
:::\frac :;
Debt to equity ratio The debt-to-equity ratio (D/E) is a financial ratio indicating the relative proportion of shareholders' equity and debt used to finance a company's assets. Closely related to leverage (finance), leveraging, the ratio is also known as risk, gearing o ...
Groppelli, p. 441. :::\frac :;Long-term Debt to equity (LT Debt to Equity) :::\frac :; Times interest earned ratio (Interest Coverage Ratio) :::\frac :::OR :::\frac :;
Debt service coverage ratioThe debt service coverage ratio (DSCR), also known as "debt coverage ratio" (DCR), is the ratio of operating income available to debt servicing for interest, principal and lease payments. It is a popular benchmark used in the measurement of an entit ...
:::\frac


Market ratios

Market ratios measure investor response to owning a company's stock and also the cost of issuing stock. These are concerned with the return on investment for shareholders, and with the relationship between return and the value of an investment in company's shares. :;
Earnings per share Earnings per share (EPS) is the monetary value of earnings Earnings are the net benefits of a corporation A corporation is an organization—usually a group of people or a company—authorized by the State (polity), state to act as a sing ...

Earnings per share
(EPS) :::\frac :; Payout ratioGroppelli, p. 446.Groppelli, p. 449. :::\frac :::OR :::\frac :;
Dividend coverDividend cover, also commonly known as dividend coverage, is the ratio of company's earnings (net income) over the dividend paid to shareholders, calculated as net profit or loss attributable to ordinary shareholders by total ordinary dividend. So, i ...
(the inverse of Payout Ratio) :::\frac :; P/E ratio :::\frac :;
Dividend yield The dividend yield or dividend–price ratio of a share is the dividend A dividend is a distribution of profit Profit may refer to: Business and law * Profit (accounting), the difference between the purchase price and the costs of bringing t ...
:::\frac :;Cash flow ratio or Price/cash flow ratioGroppelli, p. 447. :::\frac :; Price to book value ratio (P/B or PBV) :::\frac :; Price/sales ratio :::\frac :;
PEG ratio The 'PEG ratio' ( price/earnings to growth ratio) is a valuation metric for determining the relative trade-off between the price of a stock, the earnings generated per share (EPS), and the company's expected growth. In general, the P/E ratio is h ...
:::\frac Other Market Ratios :; EV/EBITDA :::\frac :;
EV/Sales Enterprise value/sales is a financial ratio that compares the total value (as measured by enterprise value) of the company to its sales. The ratio is, strictly speaking, denominated in years; it demonstrates how many dollars of EV are generated by o ...
:::\frac :;Cost/Income ratio Sector-specific ratios :;EV/capacity :;EV/output


Capital budgeting ratios

In addition to assisting management and owners in diagnosing the financial health of their company, ratios can also help managers make decisions about investments or projects that the company is considering to take, such as acquisitions, or expansion. Many formal methods are used in capital budgeting, including the techniques such as *
Net present value The net present value (NPV) or net present worth (NPW) applies to a series of cash flows occurring at different times. The present value of a cash flow depends on the interval of time between now and the cash flow. It also depends on the discount ra ...
*
Profitability index Profitability index (PI), also known as profit investment ratio (PIR) and value investment ratio (VIR), is the ratio of payoff to investment of a proposed project. It is a useful tool for ranking projects because it allows you to quantify the amo ...
*
Internal rate of return Internal rate of return (IRR) is a method of calculating an investment Investment is the dedication of an asset to attain an increase in value over a period of time. Investment requires a sacrifice of some present asset, such as time, money, ...
* Modified internal rate of return * Equivalent annuity


See also

* List of financial performance measures *
Greeks (finance) In mathematical finance Mathematical finance, also known as quantitative finance and financial mathematics, is a field of applied mathematics Applied mathematics is the application of mathematical methods by different fields such as physics ...


References


External links


Stock Valuation Metrics
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