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, also known as accountancy, is the measurement, processing, and communication of financial and non financial information about economic entities such as businesses and corporations. Accounting, which has been called the "languag ...
, there are many standard
ratio
In mathematics, a ratio shows 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 the ...
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 or partnership) that is registered by the corporation as the legal own ...
s (owners) of a firm, and by a firm's
creditor
A creditor or lender is a party (e.g., person, organization, company, or government) that has a claim on the services of a second party. It is a person or institution to whom money is owed. The first party, in general, has provided some property ...
s.
Financial analyst
A financial analyst is a professional, undertaking financial analysis for external or internal clients as a core feature of the job.
The role may specifically be titled securities analyst, research analyst, equity analyst, investment analyst, ...
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 in which people trade financial securities and derivatives at low transaction costs. Some of the securities include stocks and bonds, raw materials and precious metals, which are known in the financial markets ...
, the market price of the shares is used in certain financial ratios.
Ratios can be expressed as a
decimal value, such as 0.10, or given as an equivalent
percent
In mathematics, a percentage (from la, per centum, "by a hundred") is a number or ratio expressed as a fraction of 100. It is often denoted using the percent sign, "%", although the abbreviations "pct.", "pct" and sometimes "pc" are also use ...
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 ...
, 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 pol ...
; 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, a balance sheet (also known as statement of financial position or statement of financial condition) is a summary of the financial balances of an individual or organization, whether it be a sole proprietorship, a business ...
,
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'', ''stateme ...
,
statement of cash flows
In financial accounting, a cash flow statement, also known as ''statement of cash flows'', is a financial statement that shows how changes in balance sheet accounts and income affect cash and cash equivalents, and breaks the analysis down to opera ...
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 sole trader, statement of changes in partners' equity for a partnership, statement of changes in shareholders' equity for a company or statement of cha ...
. 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
![Federal debt to Federal revenue ratio](https://upload.wikimedia.org/wikipedia/commons/3/39/Federal_debt_to_Federal_revenue_ratio.webp)
Financial ratios quantify many aspects of a business and are an integral part of the
financial statement analysis
Financial statement analysis (or just financial analysis) is the process of reviewing and analyzing a company's financial statements to make better economic decisions to earn income in future. These statements include the income statement, balanc ...
. 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 that indicates the percentage of a company's assets that are provided via debt. It is the ratio of total debt ( short-term and long-term liabilities) and total assets (the sum of current assets, fixed assets, and oth ...
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 or partnership) that is registered by the corporation as the legal own ...
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 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 basis are the two primary methods of tracking income and expenses in accounting.
Both can ...
or follow various
standard accounting practice
Publicly traded companies typically are subject to rigorous standards. Small and midsized businesses often follow more simplified standards, plus any specific disclosures required by their specific lenders and shareholders. Some firms operate on th ...
s. Most
public companies
A public company is a company whose ownership is organized via shares of stock which are intended to be freely traded on a stock exchange or in over-the-counter markets. A public (publicly traded) company can be listed on a stock exchange (list ...
are required by law to use
generally accepted accounting principles
Publicly traded companies typically are subject to rigorous standards. Small and midsized businesses often follow more simplified standards, plus any specific disclosures required by their specific lenders and shareholders. Some firms operate on th ...
for their home countries, but
private companies
A privately held company (or simply a private company) is a company whose shares and related rights or obligations are not offered for public subscription or publicly negotiated in the respective listed markets, but rather the company's stock is ...
,
partnership
A partnership is an arrangement where parties, known as business partners, agree to cooperate to advance their mutual interests. The partners in a partnership may be individuals, businesses, interest-based organizations, schools, governments o ...
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. A sole ...
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 standards issued by the IFRS Foundation and the International Accounting Standards Board (IASB). They constitute a standardised way of describing the company's f ...
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 '' network of networks'' that consists of private, pub ...
.
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 r ...
reported by a firm are usually
net sales
In bookkeeping, accounting, and financial accounting, net sales are operating revenues earned by a company for selling its products or rendering its services. Also referred to as revenue, they are reported directly on the income statement as ''Sal ...
, which deduct returns, allowances, and early payment discounts from the charge on an
invoice
An invoice, bill or tab is a commerce, commercial document issued by a sales, seller to a buyer relating to a sale transaction and indicating the product (business), products, quantities, and agreed-upon prices for products or Service (economic ...
.
Net income
In business and accounting, net income (also total comprehensive income, net earnings, net profit, bottom line, sales profit, or credit sales) is an entity's income minus cost of goods sold, expenses, depreciation and amortization, interest, a ...
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 shares to prevail in any stockholders' motion. A majority of voting shares (over 50%) is always a controlling interest. When a party holds less than the majo ...
), 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 EBIT, Ebit or ebit may refer to:
*EBIT, or Earnings before interest and taxes, in finance
*EBIT, or Electron beam ion trap, in physics
*An ebit (quantum state), a two-party quantum state with quantum entanglement
Quantum entanglement is the ph ...
=
Earnings Earnings are the net benefits of a corporation's operation. Earnings is also the amount on which corporate tax is due. For an analysis of specific aspects of corporate operations several more specific terms are used as EBIT (earnings before interes ...
before
interest
In finance and economics, interest is payment from a borrower or deposit-taking financial institution to a lender or depositor of an amount above repayment of the principal sum (that is, the amount borrowed), at a particular rate. It is distinct ...
and
taxes
A tax is a compulsory financial charge or some other type of levy imposed on a taxpayer (an individual or legal entity) by a governmental organization in order to fund government spending and various public expenditures (regional, local, or ...
*
EBITDA
A company's earnings before interest, taxes, depreciation, and amortization (commonly abbreviated EBITDA, pronounced , , or ) is a measure of a company's profitability of the operating business only, thus before any effects of indebtedness, stat ...
= Earnings before interest, taxes,
depreciation
In accountancy, depreciation is a term that 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 a ...
, and
amortization
Amortization or amortisation may refer to:
* The process by which loan principal decreases over the life of an amortizing loan
* Amortization (accounting), the expensing of acquisition cost minus the residual value of intangible assets in a system ...
*
EPS
EPS, EPs or Eps may refer to:
Commerce and finance
* Earnings per share
* Electronic Payment Services, in Hong Kong, Macau, and Shenzhen, China
* Express Payment System, in the Philippines
Education
* Edmonton Public Schools, in Edmonton, Al ...
= 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 and cost of goods sold (COGS), divided by revenue. Gross margin is expressed as a percentage. Generally, it is calculated as the selling price of an item, less the cost of goods sold (e. g. production ...
, Gross profit margin or Gross Profit Rate
[Williams, p. 1094.]
::: :::OR :::
:;
Operating margin In business, operating margin—also known as operating income margin, operating profit margin, EBIT margin and return on sales (ROS)—is the ratio of operating income ("operating profit" in the UK) to net sales, usually expressed in percent.
: ...
, Operating Income Margin, Operating profit margin or Return on sales (ROS)
:::
:::* 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 and finance, earnings before interest and taxes (EBIT) is a measure of a firm's profit that includes all incomes and expenses (operating and non-operating) except interest expenses and income tax expenses.
Operating income and op ...
/ Sales)
:;
Profit margin
Profit margin is a measure of profitability. It is calculated by finding the profit as a percentage of the revenue.
\text = =
There are 3 types of profit margins: gross profit margin, operating profit margin and net profit margin.
* Gross Prof ...
, net margin or net profit margin
[Groppelli, p. 444.]
:::
:;
Return on equity
The return on equity (ROE) is a measure of the profitability of a business in relation to the equity. Because shareholder's equity can be calculated by taking all assets and subtracting all liabilities, ROE can also be thought of as a return on '' ...
(ROE)
:::
:;
Return on assets The return on assets (ROA) shows the percentage of how profitable a company's assets are in generating revenue.
ROA can be computed as below:
:\mathrm = \frac
This number tells you what the company can do with what it has, ''i.e.'' how many dolla ...
(ROA ratio or
Du Pont Ratio
DuPont analysis (also known as the DuPont identity, DuPont equation, DuPont framework, DuPont model or the DuPont method) is an expression which breaks ROE (return on equity) into three parts.
The name comes from the DuPont company that began usi ...
)
:::
:;
Return on assets The return on assets (ROA) shows the percentage of how profitable a company's assets are in generating revenue.
ROA can be computed as below:
:\mathrm = \frac
This number tells you what the company can do with what it has, ''i.e.'' how many dolla ...
(ROA)
:::
:;
Return on assets Du Pont
DuPont analysis (also known as the DuPont identity, DuPont equation, DuPont framework, DuPont model or the DuPont method) is an expression which breaks ROE (return on equity) into three parts.
The name comes from the DuPont company that began usi ...
(ROA Du Pont)
:::
:;
Return on Equity Du Pont (ROE Du Pont)
:::
:;
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)
:::
:;
Return on capital Return on capital (ROC), or return on invested capital (ROIC), is a ratio used in finance, valuation and accounting, as a measure of the profitability and value-creating potential of companies relative to the amount of capital invested by sharehold ...
(ROC)
:::
:;
Risk adjusted return on capital
Risk-adjusted return on capital (RAROC) is a risk-based profitability measurement framework for analysing risk-adjusted financial performance and providing a consistent view of profitability across businesses. The concept was developed by Bankers ...
(RAROC)
::: :::OR :::
:;
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)
:::
:::*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 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 internal rate of return ( ...
(CFROI)
:::
:;
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 minimizi ...
:::
:;Net gearing
:::
:;Basic Earnings Power Ratio
:::
Liquidity ratios
Liquidity
Liquidity is a concept in economics involving the convertibility of assets and obligations. It can include:
* Market liquidity, the ease with which an asset can be sold
* Accounting liquidity, the ability to meet cash obligations when due
* Liqui ...
ratios measure the availability of cash to pay debt.
:;
Current ratio (Working Capital Ratio)[Groppelli, p. 435.]
:::
:;
Acid-test ratio (Quick ratio)
:::
:;
Cash ratio
Reserve requirements are central bank regulations that set the minimum amount that a commercial bank must hold in liquid assets. This minimum amount, commonly referred to as the commercial bank's reserve, is generally determined by the centra ...
:::
:;
Operating cash flow In financial accounting, operating cash flow (OCF), cash flow provided by operations, cash flow from operating activities (CFO) or free cash flow from operations (FCFO), refers to the amount of cash a company generates from the revenues it brings in ...
ratio
:::
Activity ratios (Efficiency Ratios)
Activity ratios measure the effectiveness of the firm's use of resources.
:;
Average collection period
:::365 Days
:;
Degree of Operating Leverage
Degree may refer to:
As a unit of measurement
* Degree (angle), a unit of angle measurement
** Degree of geographical latitude
** Degree of geographical longitude
* Degree symbol (°), a notation used in science, engineering, and mathematics
...
(DOL)
:::
:;
DSO Ratio
In accountancy, days sales outstanding (also called DSO and days receivables) is a calculation used by a company to estimate the size of their outstanding accounts receivable. It measures this size not in units of currency, but in average sales da ...
.
:::365 Days
:;Average payment period
:::365 Days
:;
Asset turnover Asset 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 ...
:::
:;
Stock turnover
In accounting, the inventory turnover is a measure of the number of times inventory is sold or used in a time period such as a year. It is calculated to see if a business has an excessive inventory in comparison to its sales level. The equation ...
ratio
:::
:;
Receivables Turnover Ratio
:::
:;Inventory conversion ratio
:::
:;Inventory conversion period (essentially same thing as above)
:::365 Days
:;Receivables conversion period
:::365 Days
:;Payables conversion period
:::365 Days
:;
Cash Conversion Cycle
In management accounting, the Cash conversion cycle (CCC) measures how long a firm will be deprived of cash if it increases its investment in inventory in order to expand customer sales. It is thus a measure of the liquidity risk entailed by growt ...
:::
Debt ratios (leveraging ratios)
Debt ratios quantify the firm's ability to repay long-term debt. Debt ratios measure
financial leverage
In finance, leverage (or gearing in the United Kingdom and Australia) is any technique involving borrowing funds to buy things, hoping that future profits will be many times more than the cost of borrowing. This technique is named after a lever i ...
.
:;
Debt ratio
Debt Ratio is a financial ratio that indicates the percentage of a company's assets that are provided via debt. It is the ratio of total debt ( short-term and long-term liabilities) and total assets (the sum of current assets, fixed assets, and oth ...
:::
:;
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 leveraging, the ratio is also known as risk, gearing or leverage. The two ...
[Groppelli, p. 441.]
:::
:;Long-term Debt to equity (LT Debt to Equity)
:::
:;
Times interest earned ratio (Interest Coverage Ratio)
:::
:::OR
:::
:;
Debt service coverage ratio
:::
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 per outstanding share of common stock for a company. It is a key measure of corporate profitability and is commonly used to price stocks.
In the United States, the Financial Accounting ...
(EPS)
:::
:;
Payout ratio The dividend payout ratio is the fraction of net income a firm pays to its stockholders in dividends:
:\mbox=\frac
The part of earnings not paid to investors is left for investment to provide for future earnings growth. Investors seeking high curr ...
[Groppelli, p. 446.][Groppelli, p. 449.]
:::
:::OR
:::
:;
Dividend cover Dividend 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, ...
(the inverse of Payout Ratio)
:::
:;
P/E ratio
:::
:;
Dividend yield
The dividend yield or dividend–price ratio of a share is the dividend per share, divided by the price per share. It is also a company's total annual dividend payments divided by its market capitalization, assuming the number of shares is constant ...
:::
:;Cash flow ratio or
Price/cash flow ratio[Groppelli, p. 447.]
:::
:;
Price to book value ratio (P/B or PBV)
:::
:;
Price/sales ratio
:::
:;
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 ...
:::
Other Market Ratios
:;
EV/EBITDA
:::
:;
EV/Sales Enterprise value/sales is a financial ratio that compares the total value (as measured by enterprise value Enterprise value (EV), total enterprise value (TEV), or firm value (FV) is an economic measure reflecting the market value of a business (i.e ...
:::
:;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 ...
*
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’s rate of return. The term ''internal'' refers to the fact that the calculation excludes external factors, such as the risk-free rate, inflation, the cost of capital, or fin ...
*
Modified internal rate of return
*
Equivalent annuity
See also
*
List of financial performance measures
This article comprises a list of measures of financial performance.
Return measures
* Arithmetic return: average return of different observation periods
* Geometric return: return depending only on start date and end date of one overall obser ...
*
Greeks (finance)
In mathematical finance, the Greeks are the quantities representing the sensitivity of the price of derivatives such as options to a change in underlying parameters on which the value of an instrument or portfolio of financial instruments is de ...
References
External links
Stock Valuation Metrics
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