Profitability Ratios: and Allowances) Minus Cost of Sales

Profitability Ratios
1. Gross Profit Rate = Gross Profit Net Sales

Evaluates how much gross profit is generated from sales. Gross profit is equal to net sales (sales minus sales returns, discounts,
and allowances) minus cost of sales.
2. Return on Sales = Net Income Net Sales
Also known as "net profit margin" or "net profit rate", it measures the percentage of income derived from dollar sales. Generally, the
higher the ROS the better.
3. Return on Assets = Net Income Average Total Assets
In financial analysis, it is the measure of the return on investment. ROA is used in evaluating management's efficiency in using
assets to generate income.
4. Return on Stockholders' Equity = Net Income Average Stockholders' Equity
Measures the percentage of income derived for every dollar of owners' equity.
Liquidity Ratios
1. Current Ratio = Current Assets Current Liabilities
Evaluates the ability of a company to pay short-term obligations using current assets (cash, marketable securities, current
receivables, inventory, and prepayments).
2. Acid Test Ratio = Quick Assets Current Liabilities
Also known as "quick ratio", it measures the ability of a company to pay short-term obligations using the more liquid types of current
assets or "quick assets" (cash, marketable securities, and current receivables).
3. Cash Ratio = ( Cash + Marketable Securities ) Current Liabilities
Measures the ability of a company to pay its current liabilities using cash and marketable securities. Marketable securities are short-
term debt instruments that are as good as cash.
4. Net Working Capital = Current Assets - Current Liabilities
Determines if a company can meet its current obligations with its current assets; and how much excess or deficiency there is.
Management Efficiency Ratios
1. Receivable Turnover = Net Credit Sales Average Accounts Receivable
Measures the efficiency of extending credit and collecting the same. It indicates the average number of times in a year a company
collects its open accounts. A high ratio implies efficient credit and collection process.
2. Days Sales Outstanding = 360 Days Receivable Turnover
Also known as "receivable turnover in days", "collection period". It measures the average number of days it takes a company to
collect a receivable. The shorter the DSO, the better. Take note that some use 365 days instead of 360.
3. Inventory Turnover = Cost of Sales Average Inventory
Represents the number of times inventory is sold and replaced. Take note that some authors use Sales in lieu of Cost of Sales in
the above formula. A high ratio indicates that the company is efficient in managing its inventories.
4. Days Inventory Outstanding = 360 Days Inventory Turnover
Also known as "inventory turnover in days". It represents the number of days inventory sits in the warehouse. In other words, it
measures the number of days from purchase of inventory to the sale of the same. Like DSO, the shorter the DIO the better.
5. Accounts Payable Turnover = Net Credit Purchases Ave. Accounts Payable
Represents the number of times a company pays its accounts payable during a period. A low ratio is favored because it is better to
delay payments as much as possible so that the money can be used for more productive purposes.
6. Days Payable Outstanding = 360 Days Accounts Payable Turnover
Also known as "accounts payable turnover in days", "payment period". It measures the average number of days spent before paying
obligations to suppliers. Unlike DSO and DIO, the longer the DPO the better (as explained above).
7. Operating Cycle = Days Inventory Outstanding + Days Sales Outstanding
Measures the number of days a company makes 1 complete operating cycle, i.e. purchase merchandise, sell them, and collect the
amount due. A shorter operating cycle means that the company generates sales and collects cash faster.
8. Cash Conversion Cycle = Operating Cycle - Days Payable Outstanding
CCC measures how fast a company converts cash into more cash. It represents the number of days a company pays for purchases,
sells them, and collects the amount due. Generally, like operating cycle, the shorter the CCC the better.
9. Total Asset Turnover = Net Sales Average Total Assets
Measures overall efficiency of a company in generating sales using its assets. The formula is similar to ROA, except that net sales is
used instead of net income.
Leverage Ratios
1. Debt Ratio = Total Liabilities Total Assets
Measures the portion of company assets that is financed by debt (obligations to third parties). Debt ratio can also be computed
using the formula: 1 minus Equity Ratio.
2. Equity Ratio = Total Equity Total Assets
Determines the portion of total assets provided by equity (i.e. owners' contributions and the company's accumulated profits). Equity
ratio can also be computed using the formula: 1 minus Debt Ratio.
The reciprocal of equity ratio is known as equity multiplier, which is equal to total assets divided by total equity.
3. Debt-Equity Ratio = Total Liabilities Total Equity
Evaluates the capital structure of a company. A D/E ratio of more than 1 implies that the company is a leveraged firm; less than 1
implies that it is a conservative one.
4. Times Interest Earned = EBIT Interest Expense
Measures the number of times interest expense is converted to income, and if the company can pay its interest expense using the
profits generated. EBIT is earnings before interest and taxes.
Valuation and Growth Ratios
1. Earnings per Share = ( Net Income - Preferred Dividends ) Average Common Shares Outstanding
EPS shows the rate of earnings per share of common stock. Preferred dividends is deducted from net income to get the earnings
available to common stockholders.
2. Price-Earnings Ratio = Market Price per Share Earnings per Share
Used to evaluate if a stock is over- or under-priced. A relatively low P/E ratio could indicate that the company is under-priced.
Conversely, investors expect high growth rate from companies with high P/E ratio.
3. Dividend Pay-out Ratio = Dividend per Share Earnings per Share
Determines the portion of net income that is distributed to owners. Not all income is distributed since a significant portion is retained
for the next year's operations.
4. Dividend Yield Ratio = Dividend per Share Market Price per Share
Measures the percentage of return through dividends when compared to the price paid for the stock. A high yield is attractive to
investors who are after dividends rather than long-term capital appreciation.
5. Book Value per Share = Common SHE Average Common Shares
Indicates the value of stock based on historical cost. The value of common shareholders' equity in the books of the company is
divided by the average common shares outstanding.
Conclusion
Here's a tip. When computing for a ratio that involves an income statement item and a balance sheet item, make sure to average
the balance sheet item. This is because the income statement item pertains to a whole period's activity. The balance sheet item
should reflect the whole period as well; that's why we average.
There are other financial ratios in addition those listed above. The ones listed here are the most common ratios used in evaluating a
business. In interpreting the ratios, it is better to have a basis for comparison, such as past performance and industry standards.

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Profitability Ratios

1. Gross Profit Rate = Gross Profit Net Sales

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