When investors perform a financial analysis of a company, they examine a number of different financial ratios for insight into the firm's past and future performance. The basic financial ratios for historical financial statement analysis can be split into three categories: liquidity analysis (the company's ability to satisfy its obligations), leverage analysis (the level of debt held by the company), and activity and performance analysis (measures of efficiency and profitability of the company).
The current ratio, a liquidity ratio, is computed by dividing the firm's current assets by its current liabilities. This ratio shows the ability of the firm to repay short-term obligations. Ratios of less than 1.00 may indicate the firm will have difficulty meeting these obligations.
Operating Cash Flow Ratio
The operating cash flow ratio, a liquidity ratio, is computed by dividing cash flows from operations by current liabilities. This ratio shows the firm's ability to continue meeting short-term obligations and is less immediate than the current ratio.
Debt to Equity Ratio
The debt to equity ratio, a leverage ratio, is computed by dividing total debt by total stockholders' equity. This ratio, the most common measure of the firm's capital structure, is a direct measure of the firm's leverage.
Interest Coverage Ratio
The interest coverage ratio, a leverage ratio, is computed by adding the firm's net income, interest expense, and tax expense and dividing by the firm's interest expense. This measures the firm's ability to continue making interest payments. It is also commonly referred to as the "times interest earned" ratio.
The gross margin ratio, a profitability ratio, is computed by subtracting the cost of goods sold from gross revenues and dividing the result by net sales. This is a raw measure of the firm's profitability from operations.
Return on Equity
The return on equity ratio, a profitability ratio, is computed by dividing net income by the average outstanding stockholders' equity. This is the core measure of shareholder profit created by the firm.
The dividend payout ratio, a profitability ratio, is computed by dividing total dividends by net income. This is a measure of earnings distributed to the shareholders. It is also used to measure the amount of earnings retained within the company for future investment or to meet future obligations.
The operating margin ratio, a profitability ratio, is computed by dividing operating income by net sales. This ratio measures the firm's ability to profit from its continuing operations, which includes gross sales margin and general and administrative costs.
- "Investments"; Zvi Bodie, Alex Kane, Alan J. Marcus; 2009
- Accounting Coach: Financial Ratios
Michael Dreiser started writing professionally in 2010. He is a certified public accountant with experience working for a large New York City accountancy and expertise in areas ranging from private equity taxation to investment management. He holds a Master of Business Administration in international finance from l’École Nationale des Ponts et Chaussées in Paris.