Financial Ratios and Business Calculations Explained
Financial ratios distill complex business data into comparable metrics. This guide covers the key ratios investors and managers use to evaluate profitability, liquidity, and efficiency.
Key Takeaways
- Formula: `(Revenue - COGS) / Revenue * 100`
- Formula: `Current Assets / Current Liabilities`
- Formula: `Share Price / Earnings Per Share`
- No single ratio tells the complete story.
- Always compare ratios against industry benchmarks and track trends over multiple periods rather than relying on a single snapshot.
Ratio Calculator
Simplify, scale, and find equivalent ratios
Profitability Ratios
Gross Profit Margin
Formula: (Revenue - COGS) / Revenue * 100
Measures how much profit remains after direct production costs. A software company might have 80% gross margin; a grocery store, 25%.
Net Profit Margin
Formula: Net Income / Revenue * 100
Accounts for all expenses including taxes and interest. This is the bottom-line profitability measure.
Return on Equity (ROE)
Formula: Net Income / Shareholder Equity * 100
Shows how effectively the company uses investor capital. An ROE above 15% is generally considered strong.
Liquidity Ratios
Current Ratio
Formula: Current Assets / Current Liabilities
A ratio above 1.0 means the company can cover short-term obligations. Below 1.0 signals potential cash flow problems.
Quick Ratio (Acid Test)
Formula: (Cash + Receivables + Short-term Investments) / Current Liabilities
Excludes inventory, which may be hard to liquidate quickly. A more conservative liquidity measure.
Efficiency Ratios
| Ratio | Formula | Meaning |
|---|---|---|
| Inventory Turnover | COGS / Average Inventory | How fast inventory sells |
| Receivables Turnover | Revenue / Average Receivables | How fast customers pay |
| Asset Turnover | Revenue / Total Assets | Revenue per dollar of assets |
Valuation Ratios
Price-to-Earnings (P/E)
Formula: Share Price / Earnings Per Share
A P/E of 20 means investors pay $20 for every $1 of earnings. Compare within the same industry — tech companies typically trade at higher P/E ratios than utilities.
Practical Tip
No single ratio tells the complete story. Always compare ratios against industry benchmarks and track trends over multiple periods rather than relying on a single snapshot.