Financial Ratios & Categories
What Are Financial Ratios?
Financial ratios are analytical tools used to evaluate the relationship between key numerical values found in a company's financial statements. These ratios help investors, analysts, and managers assess a company’s performance, financial health, and operational efficiency.
Ratios can be expressed in various formats:
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As a decimal (e.g., 0.20)
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As a percentage (e.g., 20%)
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As a multiple (e.g., a P/E ratio of 15x)
When a ratio exceeds 1 and is used in a comparative context, such as price-to-earnings (P/E) or enterprise value-to-EBITDA, it is often referred to as a multiple.
Major Categories of Financial Ratios
Financial ratios are typically grouped into five core categories, each serving a specific purpose in financial analysis:
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Profitability Ratios
Measure a company’s ability to generate earnings relative to sales, assets, or equity.
Example: Net Profit Margin, Return on Equity (ROE)
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Cash Flow Ratios
Assess how well a company can generate and manage cash to meet obligations.
Example: Operating Cash Flow Ratio, Free Cash Flow to Equity
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Efficiency Ratios
Evaluate how effectively a company utilizes its assets and manages its operations.
Example: Inventory Turnover, Asset Turnover Ratio
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Valuation Ratios (Value Ratios)
Help determine a company's market value relative to financial metrics.
Example: Price-to-Earnings (P/E), Price-to-Book (P/B), EV/EBITDA
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Leverage Ratios
Analyze the degree of financial risk by measuring a company’s use of debt.
Example: Debt-to-Equity Ratio, Interest Coverage Ratio
(I) Profitability ratios
Profitability ratios assess how efficiently a company operates to generate profits. These ratios are typically divided into two key subcategories: margin ratios, which evaluate a company's ability to convert revenue into profit, and return ratios, which measure the returns generated on assets, equity, or invested capital.
Important Profitability Ratios:
1) Cash return on capital invested
2) Contribution margin
3) EBIT and EBITDA
4) EBITDA margin
5) Gross margin
6) Net margin
7) Operating income margin
8) Return on capital employed
9) Return on debt
10) Return on equity
11) Return on invested capital
12) Return on investment
13) Return on net assets
14) Return on total assets
15) Return on total capital
(II) Cash Flow Ratios
Cash flow ratios assess a company's ability to meet its short-term liquidity needs by evaluating whether it generates sufficient cash to cover its financial obligations efficiently. These ratios also indicate the company’s capacity to seize investment opportunities and fund operations with minimal reliance on external financing.
Important Cash flow ratios:
1. Cash flow to debt ratio
2. Cash flow to sales ratio
3. Dividend coverage ratio
4. Free to Operating Cash Flow Ratio
5. Operating cash flow ratio
(III) Efficiency Ratios
Efficiency ratios measure how effectively a company utilizes its assets to generate revenue. These ratios assess operational performance, such as how well a business manages its inventory, receivables, or overall asset base to support sales and growth.
Important Efficiency ratios:
1. Cash cycle
2. Equity turnover
3. Asset turnover
4. Sales per employee
5. Inventory turnover ratio
6. Payable turnover
7. Receivable turnover ratio
8. Day sales outstanding
9. Days inventory outstanding
10. Days payable outstanding
(IV) Value ratios
Valuation ratios measure the relative worth of a company’s shares, helping investors assess whether a stock is overvalued, undervalued, or fairly priced. These ratios typically incorporate either the current share price or the company’s total market capitalization (calculated as share price × number of outstanding shares).
Important Value Ratios:
1) EPS (earnings per share)
2) P/E (price/earnings)
3) Price / Cash ratio
4) Dividend Yield (%)
5) P/Bv (Price to Book Value)
6) Market / Book Ratio
7) P/S (Price to Sales Ratio)
(V) Leverage ratios
Leverage ratios assess the extent to which a company uses borrowed funds (debt) to finance its operations and growth. These ratios evaluate the relationship between debt, equity, assets, and earnings to understand the company’s financial risk and its ability to meet financial obligations.
Important Leverage Ratios:
1) Capital employed
2) Capital expenditure ratio
3) Capitalization ratio
4) Debt ratio
5) Debt-to-equity ratio
6) Debt/EBITDA ratio
7) Equity ratio
□ Financial Ratios
G. P. for Crowdholder.com (c)
