Sources of dataValues used in calculating financial ratios are taken from the balance sheet, income statement, statement of cash flows or (sometimes) the statement of changes in equity. These comprise the firm's "accounting statements" or financial statements. The statements' data is based on the accounting method and accounting standards used by the organisation.
Purpose and typesFinancial ratios quantify many aspects of a business and are an integral part of the financial statement analysis. 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 ratios 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 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 Benchmarking, 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 principlesFinancial ratios may not be directly comparable between companies that use different accounting methods or follow various standard accounting practices. Most public company, public companies are required by law to use generally accepted accounting principles for their home countries, but private company, private companies, partnerships and sole proprietorships may elect to not use accrual basis accounting. Large multi-national corporations may use International Financial Reporting Standards 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 terminologyVarious abbreviations may be used in financial statements, especially financial statements summarized on the Internet. Sales (accounting), Sales reported by a firm are usually net sales, which deduct returns, allowances, and early payment discounts from the charge on an invoice. Net income 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), 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.) * Cost of goods sold, COGS = Cost of goods sold, or cost of sales. * Earnings before interest and taxes, EBIT = Net income, Earnings before interest and taxes * EBITDA = Earnings before interest, taxes, depreciation, and amortization * Earnings per share, EPS = Earnings per share
Profitability ratiosProfitability ratios measure the company's use of its assets and control of its expenses to generate an acceptable rate of return :;Gross margin, Gross profit margin or Gross Profit RateWilliams, p. 1094. ::: :::OR ::: ---- :;Operating margin, 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 / Sales) ---- :;Profit margin, net margin or net profit marginGroppelli, p. 444. ::: ---- :;Return on equity (ROE) ::: ---- :;Return on assets (ROA ratio or Du Pont Ratio) ::: ---- :;Return on assets (ROA) ::: ---- :;Return on assets Du Pont (ROA Du Pont) ::: ---- :;Return on Equity Du Pont (ROE Du Pont) ::: ---- :;Return on net assets (RONA) ::: ---- :;Return on capital (ROC) ::: ---- :;Risk adjusted return on capital (RAROC) ::: :::OR ::: ---- :;Return on capital employed (ROCE) ::: :::Note: this is somewhat similar to (ROI), which calculates Net Income per Owner's Equity ---- :;Cash flow return on investment (CFROI) ::: ---- :;Efficiency ratio ::: ---- :;Net gearing ::: ---- :;Basic Earnings Power Ratio ::: ---- ----
Liquidity ratiosAccounting liquidity, Liquidity ratios measure the availability of cash to pay debt. :;Current ratio, Current ratio (Working Capital Ratio)Groppelli, p. 435. ::: ---- :;Quick ratio, Acid-test ratio (Quick ratio) ::: ---- :;Cash ratio ::: ---- :;Operating cash flow ratio ::: ----
Activity ratios (Efficiency Ratios)Activity ratios measure the effectiveness of the firm's use of resources. :;Debtor collection period, Average collection period ::: :;Operating leverage#DOL and Operating income, Degree of Operating Leverage (DOL) ::: :;DSO Ratio. ::: :;Average payment period ::: :;Asset turnover ::: :;Stock turnover ratio ::: :;Receivables Turnover Ratio ::: :;Inventory conversion ratio ::: :;Inventory conversion period (essentially same thing as above) ::: :;Receivables conversion period ::: :;Payables conversion period ::: :;Cash conversion cycle, Cash Conversion Cycle :::
Debt ratios (leveraging ratios)Debt ratios quantify the firm's ability to repay long-term debt. Debt ratios measure leverage (finance), financial leverage. :;Debt ratio ::: :;Debt to equity ratioGroppelli, p. 441. ::: :;Long-term Debt to equity (LT Debt to Equity) ::: :;Times interest earned, Times interest earned ratio (Interest Coverage Ratio) ::: :::OR ::: :;Debt service coverage ratio :::
Market ratiosMarket 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 (EPS) ::: :;Payout ratioGroppelli, p. 446.Groppelli, p. 449. ::: :::OR ::: :;Dividend cover (the inverse of Payout Ratio) ::: :;PE ratio, P/E ratio ::: :;Dividend yield ::: :;Cash flow ratio or Price/cash flow ratioGroppelli, p. 447. ::: :;P/B ratio, Price to book value ratio (P/B or PBV) ::: :;Price/sales ratio ::: :;PEG ratio ::: Other Market Ratios :;EV/EBITDA ::: :;EV/Sales ::: :;Cost/Income ratio Sector-specific ratios :;EV/capacity :;EV/output
Capital budgeting ratiosIn 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 * Profitability index * Internal rate of return * Modified internal rate of return * Equivalent annual cost, Equivalent annuity
See also* List of financial performance measures * Greeks (finance)