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Five key types of ratios that help analyze a company's financial performance:
- Liquidity Ratios:
Purpose: Measure a company’s ability to cover its short-term obligations with its current assets.
Key Ratios:
Current Ratio
Quick Ratio (Acid-Test Ratio)
Cash Ratio
Defensive Interval
Importance: Crucial for assessing a company's short-term financial health and ability to avoid insolvency.
- Profitability Ratios:
Purpose: Analyze how effectively a company generates profit from its assets, equity, or revenue.
Key Ratios:
Net Profit Margin
Return on Assets (ROA)
Return on Equity (ROE)
Gross Profit Margin
Operating Profit Margin
Pre-Tax Margin
Importance: Essential for evaluating the company's earnings relative to its revenue, assets, and equity, helping to attract investors.
- Solvency Ratios:
Purpose: Evaluate a company’s ability to meet its long-term obligations.
Key Ratios:
Debt-to-Equity Ratio
Interest Coverage Ratio
Debt-to-Assets Ratio
Debt-to-Capital Ratio
Fixed-Charge Coverage
Financial Leverage
Importance: Provides insights into the company's financial structure and risk profile, focusing on long-term sustainability.
- Activity Ratios:
Purpose: Assess how well a company manages its normal business operations.
Key Ratios:
Cash Conversion Cycle
Receivables Turnover
Payables Turnover
Debt-to-Capital Ratio
Working Capital Turnover
Inventory Turnover
Days Inventory Outstanding (DIO)
Importance: Indicates operational efficiency by showing how effectively a company manages its resources.
- Valuation Ratios:
Purpose: Determine a company's intrinsic value compared to its current market price.
Key Ratios:
Price-to-Earnings (P/E) Ratio
Price-to-Book (P/B) Ratio
Enterprise Value to EBITDA (EV/EBITDA)
Earnings per Share (EPS)
Dividend Yield
Retention Rate
Dividend Payout Ratio
Importance: Helps investors and analysts make informed decisions about buying, selling, or holding a company’s stock.
These ratios serve as decision-making tools, allow for comparability, assess risk, and monitor performance.
