Best Financial Ratios Cheat Sheet (2024)

Financial ratios are quantitative measures derived from a company’s financial statements. They help investors, analysts, and managers evaluate a company's performance and compare it to others in the industry. This financial ratio cheat sheet will walk you through the essential metrics you need to know, why they're important, and how to use them effectively.

Key Takeaways

• Financial ratios are essential tools for evaluating a company's performance and comparing it to industry standards.

• Key financial ratios include liquidity, profitability, leverage, efficiency, and market value ratios.

• Understanding and interpreting these ratios can help investors make informed investment decisions.

Key Financial Ratios Cheat Sheet

Let's break down the most critical financial ratios you should know. This financial ratio cheat sheet is your go-to resource for understanding these key metrics.

Liquidity Ratios

Liquidity ratios measure a company's ability to cover its short-term obligations with its short-term assets. They are crucial for assessing financial stability and ensuring a company can meet its immediate liabilities. Liquidity ratios include:

• Current Ratio

• Quick Ratio

• Cash Ratio

Current Ratio

The current ratio is calculated by dividing current assets by current liabilities. This ratio indicates whether the company can pay off its short-term debts with its short-term assets.

A ratio above 1 suggests the company has more assets than liabilities, which is generally a good sign of financial health.

Formula:

Current Ratio = Current Asset / Current Liabilities ​

Financial ratios formulas like this are vital when assessing liquidity and short-term stability.

Quick Ratio

The quick ratio, also known as the acid-test ratio, is a more rigorous measure of liquidity than the current ratio. It excludes inventory from current assets before dividing by current liabilities.

This ratio focuses on assets that can be quickly converted to cash, providing a clearer picture of a company’s ability to meet short-term obligations.

Formula:

Quick Ratio = Current Asset - Inventory / Current Liabilities ​

Cash Ratio

The cash ratio is a stricter liquidity ratio compared to the current and quick ratios. It measures a company’s ability to cover its short-term obligations using only cash and cash equivalents, excluding inventory and other current assets.

This ratio is particularly useful for assessing the financial health of companies in situations where immediate liquidity is essential.

Formula:

Cash Ratio = Cash and Cash Equivalents Current Liabilities

Profitability Ratios

Profitability ratios assess a company's ability to generate profit relative to sales, assets, or equity.

These ratios are vital for understanding how efficiently a company is operating and how well it is generating returns for its shareholders. They include:

• Gross Profit Margin

• Net Profit Margin

• Return on Assets (ROA)

• Return on Equity (ROE)

• Operating Profit Margin

• Dividend Yield

Gross Profit Margin

Gross profit margin is calculated by subtracting the cost of goods sold (COGS) from revenue and dividing it by revenue.

This ratio shows the percentage of revenue that exceeds the cost of goods sold, indicating how well a company controls its production costs.

Formula:

Gross Profit Margin = COGS / Revenue ​

By including such financial ratios formulas, you can effectively evaluate a company's cost efficiency.

Net Profit Margin

Net profit margin is the ratio of net income to revenue. It reflects the percentage of revenue that remains as profit after all expenses are deducted, including operating expenses, interest, taxes, and depreciation.

A higher net profit margin indicates better overall profitability and operational efficiency.

Formula:

Net Profit Margin = Net Income / Revenue ​

Return on Assets (ROA)

ROA measures how efficiently a company uses its assets to generate profit. It’s calculated by dividing net income by total assets.

A higher ROA indicates that the company uses its assets effectively to generate earnings.

Formula:

ROA = Net Income / Total Asset

This is one of the best financial ratios to evaluate a company’s operational efficiency.

Return on Equity (ROE)

ROE is the ratio of net income to shareholders' equity. It shows how effectively a company uses equity to generate profit.

A high ROE indicates that the company uses its equity base efficiently to grow its profits.

Formula:

ROE = Net Income / Shareholder's Equity

Operating Profit Margin

Operating profit margin measures the percentage of revenue remaining after covering operating expenses such as wages, rent, and materials before accounting for interest and taxes.

This ratio helps investors evaluate the efficiency of a company's core operations. A higher operating profit margin indicates better operational efficiency and profitability.

Formula:

Operating Profit Margin = Operating Income / Revenue

Dividend Yield

The dividend yield represents the return an investor can expect from dividends relative to the current stock price. It’s a critical ratio for income-focused investors who rely on dividends as a source of income.

A higher dividend yield suggests that the stock provides more income relative to its price.

Formula:

Dividend Yield = Annual Dividends per Share / Price per Share

Leverage Ratios

Leverage ratios evaluate the degree to which a company is utilizing borrowed money. By examining its debt levels relative to its equity and earnings, these ratios help assess a company's risk and financial stability. They include:

• Debt-to-Equity Ratio

• Interest Coverage Ratio

• Equity Ratio

• Debt Service Coverage Ratio (DSCR)

Debt-to-Equity Ratio

The debt-to-equity ratio is calculated by dividing total liabilities by shareholders' equity. This ratio indicates how much debt a company uses to finance its assets relative to the value of shareholders’ equity.

A lower ratio suggests less risk, while a higher ratio indicates higher leverage and potentially greater financial risk.

Formula:

Debt-to-Equity Ratio = Total Liabilities / Shareholder's Equity

Interest Coverage Ratio

The interest coverage ratio measures a company's ability to pay interest on its debt. It’s calculated by dividing earnings before interest and taxes (EBIT) by interest expenses.

A higher ratio indicates a better ability to meet interest obligations, which is a sign of financial health and stability.

Formula:

Interest Coverage Ratio = EBIT / Interest Expenses

Equity Ratio

The equity ratio measures the proportion of a company’s assets financed by shareholders’ equity. A higher equity ratio indicates a more conservative capital structure, reducing the company's reliance on debt.

Formula:

Equity Ratio = Shareholder's Equity / Total Assets

Debt Service Coverage Ratio (DSCR)

The DSCR measures a company’s ability to service its debt from its operating income.

A higher DSCR indicates a greater ability to cover debt payments, while a DSCR below 1 means the company may struggle to meet its debt obligations.

Formula:

DSCR = Net Operating Income / Total Debt Service

Efficiency Ratios

Efficiency ratios measure how well a company utilizes its assets and manages its operations. These ratios help assess the effectiveness of a company’s operations and its ability to convert resources into revenue. They include:

• Inventory Turnover Ratio

• Asset Turnover Ratio

• Days Sales Outstanding (DSO)

• Days Inventory Outstanding (DIO)

Inventory Turnover Ratio

The inventory turnover ratio is calculated by dividing the cost of goods sold by the average inventory. This ratio indicates how many times a company’s inventory is sold and replaced over a period.

A higher ratio suggests efficient inventory management and a faster turnover of inventory.

Formula:

Inventory Turnover Ratio = COGS / Average Inventory

Asset Turnover Ratio

The asset turnover ratio is the ratio of sales to total assets. It measures how efficiently a company uses its assets to generate sales.

A higher ratio indicates better utilization of assets and operational efficiency.

Formula:

Asset Turnover Ratio = Sales / Total Assets

Days Sales Outstanding (DSO)

DSO measures the average number of days it takes a company to collect payment after a sale. A lower DSO indicates that the company collects payments quickly, which is good for cash flow.

A higher DSO may suggest that the company is offering lenient credit terms or experiencing delays in collections.

Formula:

DSO = (Accounts Receivable / Total Sales) x Number of Days

Days Inventory Outstanding (DIO)

DIO shows the average number of days inventory is held before being sold. A lower DIO indicates efficient inventory management, while a higher DIO suggests slow inventory turnover.

Companies with high DIO may face excess inventory issues, leading to increased storage costs and potential markdowns.

Formula:

DIO = (Average Inventory / Cost of Goods Sold) x Number of Days

Market Value Ratios

Market value ratios help investors evaluate the market price of a company's stock relative to its financial performance. These ratios are crucial for assessing the value and growth potential of a company’s stock. They include:

• Price-to-Earnings (P/E) Ratio

• Price-to-Book (P/B) Ratio

• Price-to-Sales (P/S) Ratio

Price-to-Earnings (P/E) Ratio

The P/E ratio is calculated by dividing the current market price per share by earnings per share (EPS). This ratio indicates how much investors are willing to pay for each dollar of earnings.

A high P/E ratio suggests that investors expect higher future growth.

Formula:

P/E Ratio = Market price per share / EPS

Price-to-Book (P/B) Ratio

The P/B ratio is the ratio of the market price per share to the book value per share. It compares a company’s market value to its book value, indicating whether a stock is over or undervalued.

Formula:

P/B Ratio = Market price per share / Book Value per Share

Price-to-Sales (P/S) Ratio

The P/S ratio compares a company's stock price to its revenue per share, showing how much investors are willing to pay for each dollar of sales. A lower P/S ratio may indicate that the stock is undervalued.

Formula:

P/S Ratio = Market Price per Share / Revenue per Share

How to Calculate Financial Ratios

Knowing how to calculate these financial ratios is crucial for making informed decisions. Here are some formulas and some examples to help you get started.

Formulas and Examples

Current Ratio: Current Assets / Current Liabilities

• Example: $500,000 / $250,000 = 2.0

Gross Profit Margin: (Revenue - COGS) / Revenue

• Example: ($1,000,000 - $600,000) / $1,000,000 = 0.4 or 40%

ROA: Net Income / Total Assets

• Example: $100,000 / $1,000,000 = 0.1 or 10%

Debt-to-Equity Ratio: Total Liabilities / Shareholders' Equity

• Example: $300,000 / $500,000 = 0.6

Interest Coverage Ratio: EBIT / Interest Expenses

• Example: $200,000 / $50,000 = 4.0

Asset Turnover Ratio: Sales / Total Assets

• Example: $1,000,000 / $1,000,000 = 1.0

P/E Ratio: Market Price per Share / EPS

• Example: $50 / $5 = 10

Interpreting Financial Ratios

Interpreting financial ratios formulas involves understanding what the numbers mean in context. This financial ratios cheat sheet explains how to make sense of these ratios.

Industry Benchmarks

Comparing ratios to industry benchmarks helps determine how a company performs relative to its peers. Each industry has different standards, so what’s considered good in one sector might not be the same in another.

Trends Over Time

Analyzing financial ratios over time can reveal trends and patterns. For example, a steadily increasing ROA might indicate improving efficiency, while a declining current ratio could signal potential liquidity issues.

Comparing Companies

Financial ratios are also useful for comparing companies within the same industry. This can help identify which companies are performing better and why. It’s important to compare similar companies to ensure the ratios are meaningful.

Conclusion

Understanding and utilizing financial ratios is essential for making informed investment decisions. This financial ratio cheat sheet has provided you with a comprehensive overview of the key ratios you need to know in 2024. By mastering these metrics, you'll be better equipped to analyze companies, compare their performance, and make smarter investment choices. Join XS today and start investing!

FAQs

1. What are the 5 Key Financial Ratios?

The five key financial ratios are the Current Ratio, Quick Ratio, Gross Profit Margin, Net Profit Margin, and Return on Equity (ROE).

2. What do you Mean by Financial Ratios?

Financial ratios are quantitative metrics derived from financial statements used to evaluate a company's performance and compare it to industry standards.

3. What is the Best Financial Ratio?

There is no single best financial ratio; it depends on the context and what aspect of the company's performance you are analyzing (e.g., liquidity, profitability, efficiency).

4. What is the Difference Between the Current Ratio and the Quick Ratio?

The current ratio includes all current assets (such as inventory) in its calculation, while the quick ratio excludes inventory to focus on assets that can be quickly converted to cash. The quick ratio is, therefore, a more conservative measure of liquidity than the current ratio.

5. What are the Most Important Financial Ratios?

The most important financial ratios for investors often include the Price-to-Earnings (P/E) ratio, Return on Equity (ROE), Debt-to-Equity ratio, and Free Cash Flow to Equity (FCFE). These ratios help assess a company's profitability, financial health, and potential for future growth.