Financial ratios are quantitative measures used by businesses, investors, and analysts to evaluate a company’s financial situation and operational efficiency.
Introduction to Key Financial Ratios
Financial ratios are a tool used to measure a company’s financial performance. They are calculated by comparing two or more financial statement items. Financial ratios can be used to assess a company’s liquidity, profitability, solvency, and efficiency.
There are many different types of financial ratios, each of which measures a different aspect of a company’s financial performance. Some of the most common financial ratios include:
1. Return on Net Worth (%)
The Return on Net Worth (RONW) is a profitability ratio expressing the net profit made by a company as a percentage of the shareholders’ equity. It is computed by dividing the total comprehensive income by the average shareholder’s equity. Higher values indicate greater profitability.
2. Return on Capital Employed (%)
Return on Capital Employed (ROCE) measures a company’s ability to generate returns for both equity holders and debt holders. It’s an indicator of corporate profitability and the efficiency of capital usage. It’s calculated by dividing profit before exceptional items, interest, and tax by the capital employed, where capital employed is tangible net worth + total debt + deferred tax liability.
3. Basic Earnings per Share (EPS)
EPS is the portion of a company’s profit allocated to each outstanding share of common stock. It’s a widely used profitability indicator. EPS is determined by dividing the profit for the year by the weighted average number of shares outstanding during the year.
4. Debtors Turnover
Debtors Turnover ratio shows how efficiently a company manages its receivables. It reflects how well a company utilizes and manages the credit it extends to customers and how quickly that short-term debt is collected. It’s calculated by dividing the turnover by average trade receivables.
5. Inventory Turnover
The Inventory Turnover ratio measures a company’s efficiency in managing its inventory. It shows the relationship between sales and average inventory held during the period. This ratio is calculated by dividing turnover by average inventory.
6. Interest Coverage Ratio
The Interest Coverage Ratio assesses how many times a company can cover its current interest payments with its available earnings. This ratio is calculated by dividing earnings available for debt service by interest payments.
7. Debt Service Coverage Ratio
The Debt Service Coverage Ratio gauges a company’s ability to pay off current interest and installments. It’s computed by dividing earnings available for debt service by debt service.
8. Current Ratio
The Current Ratio indicates a company’s liquidity position, showing its ability to pay off short-term obligations due within a year. It’s calculated by dividing the current assets by current liabilities.
9. Debt Equity Ratio
The Debt Equity Ratio measures a company’s financial leverage by showing the extent to which a company is financing its operations through debt versus wholly-owned funds. It’s calculated by dividing total debt by shareholder’s equity.
10. Operating Profit Margin (%)
The Operating Profit Margin calculates the percentage of profit a company produces from its operations. It’s determined by dividing earnings before interest and tax by turnover.
11. Net Profit Margin (%)
The Net Profit Margin shows how much net profit is generated as a percentage of revenue. This ratio is calculated by dividing net profit by turnover.
