Financial Analysis

Profitability Ratios Gross Profit Rate

Gross Profit ÷ Net Sales. Evaluates how much gross profit is generated from sales. Gross profit is equal to net sales (sales minus sales returns, discounts, and allowances) minus the cost of sales.

Return on Sales

Net Income ÷ Net Sales. Also known as “net profit margin” or “net profit rate”, it measures the percentage of income derived from dollar sales. Generally, the higher the ROS the better.

Return on Assets

Net Income ÷ Average Total Assets. In financial analysis, it is the measure of the return on investment. ROA is used in evaluating management’s efficiency in using assets to generate income.

Return on Stockholders’ Equity

Net Income ÷ Average Stockholders’ Equity. Measures the percentage of income derived for every dollar of owners’ equity.

Liquidity RatiosCurrent Ratio

Current Assets ÷ Current Liabilities. Evaluates the ability of a company to pay short-term obligations using current assets (cash, marketable securities, current receivables, inventory, and prepayments).

Acid Test Ratio

Quick Assets ÷ Current Liabilities. Also known as “quick ratio”, it measures the ability of a company to pay short-term obligations using the more liquid types of current assets or “quick assets” (cash, marketable securities, and current receivables).

Cash Ratio

( Cash + Marketable Securities ) ÷ Current Liabilities. Measures the ability of a company to pay its current liabilities using cash and marketable securities. Marketable securities are short-term debt instruments that are as good as cash.

Net Working Capital

Current Assets – Current Liabilities. Determines if a company can meet its current obligations with its current assets; and how much excess or deficiency there is.

Management Efficiency RatiosReceivable Turnover

Net Credit Sales ÷ Average Accounts Receivable. Measures the efficiency of extending credit and collecting the same. It indicates the average number of times in a year a company collects its open accounts. A high ratio implies an efficient credit and collection process.

Days Sales Outstanding

360 Days ÷ Receivable Turnover. Also known as “receivable turnover in days”, “collection period”. It measures the average number of days it takes a company to collect a receivable. The shorter the DSO, the better. Take note that some use 365 days instead of 360.

Inventory Turnover

Cost of Sales ÷ Average Inventory. Represents the number of times inventory is sold and replaced. Take note that some authors use Sales in lieu of Cost of Sales in the above formula. A high ratio indicates that the company is efficient in managing its inventories.

Days Inventory Outstanding

360 Days ÷ Inventory Turnover. Also known as “inventory turnover in days”. It represents the number of days inventory sits in the warehouse. In other words, it measures the number of days from purchase of inventory to the sale of the same. Like DSO, the shorter the DIO the better.

Accounts Payable Turnover

Net Credit Purchases ÷ Ave. Accounts Payable, Represents the number of times a company pays its accounts payable during a period. A low ratio is favoured because it is better to delay payments as much as possible so that the money can be used for more productive purposes.

Days Payable Outstanding

360 Days ÷ Accounts Payable Turnover. Also known as “accounts payable turnover in days”, “payment period”. It measures the average number of days spent before paying obligations to suppliers. Unlike DSO and DIO, the longer the DPO the better (as explained above).

Operating Cycle

Days Inventory Outstanding + Days Sales Outstanding. Measures the number of days a company makes 1 complete operating cycle, i.e. purchase merchandise, sell them, and collect the amount due. A shorter operating cycle means that the company generates sales and collects cash faster.

Cash Conversion Cycle

Operating Cycle – Days Payable Outstanding. CCC measures how fast a company converts cash into more cash. It represents the number of days a company pays for purchases, sells them, and collects the amount due. Generally, like the operating cycle, the shorter the CCC the better.

Total Asset Turnover

Net Sales ÷ Average Total Assets. Measures overall efficiency of a company in generating sales using its assets. The formula is similar to ROA, except that net sales are used instead of net income.

Leverage RatiosDebt Ratio

Total Liabilities ÷ Total Assets. Measures the portion of company assets that are financed by debt (obligations to third parties). Debt ratio can also be computed using the formula: 1 minus Equity Ratio.

Equity Ratio

Total Equity ÷ Total Assets. Determines the portion of total assets provided by equity (i.e. owners’ contributions and the company’s accumulated profits). Equity ratio can also be computed using the formula: 1 minus Debt Ratio. The reciprocal of equity ratio is known as equity multiplier, which is equal to total assets divided by total equity.

Debt-Equity Ratio

Total Liabilities ÷ Total Equity. Evaluates the capital structure of a company. A D/E ratio of more than 1 implies that the company is a leveraged firm; less than 1 implies that it is a conservative one.

Times Interest Earned

EBIT ÷ Interest Expense. Measures the number of times interest expense is converted to income, and if the company can pay its interest expense using the profits generated. EBIT is earnings before interest and taxes.

Valuation and Growth RatiosEarnings per Share

( Net Income – Preferred Dividends ) ÷ Average Common Shares Outstanding. EPS shows the rate of earnings per share of common stock. Preferred dividends are deducted from net income to get the earnings available to common stockholders.

Price-Earnings Ratio

Market Price per Share ÷ Earnings per Share. Used to evaluate if a stock is over- or under-priced. A relatively low P/E ratio could indicate that the company is under-priced. Conversely, investors expect high growth rate from companies with high P/E ratio.

Dividend Payout Ratio

Dividend per Share ÷ Earnings per Share. Determines the portion of net income that is distributed to owners. Not all income is distributed since a significant portion is retained for the next year’s operations.

Dividend Yield Ratio

Dividend per Share ÷ Market Price per Share. Measures the percentage of return through dividends when compared to the price paid for the stock. A high yield is attractive to investors who are after dividends rather than long-term capital appreciation.

Book Value per Share

Common SHE ÷ Average Common Shares. Indicates the value of stock-based on historical cost. The value of common shareholders’ equity in the books of the company is divided by the average common shares outstanding


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