The top financial ratios you should be using in your next analysis
The Corporate Finance Institute has released an eBook offering a thorough summary of Financial Ratios.
The Institute offers this definition of what a Ratio Analysis is:
Corporate finance ratios are quantitative measures that are used to assess businesses. These ratios are used by financial analysts, equity research analysts, investors, and asset managers to evaluate the overall financial health of businesses, with the end goal of making better investment decisions. Corporate finance ratios are also heavily used by financial managers and C-suite officers to get a better understanding of how their businesses are performing.
The ebook describes all ratios falling into these five main categories:
Profitability
Tracks the ability of the operation to generate income and profit by taking into account revenue, balance sheet assets, operating costs and shareholder equity during the time period the ratio is monitoring.
Examples of Return Ratios include:
- Return on Equity
- Return on Assets
- Return on Capital employed
Also in this category are Margin Ratios including:
- Gross Margin
- Operating Profit
- Net Profit
Leverage
This ratio provides a signal on the level of debt in relation to other factors including accounts in the balance sheet, income statement or cash flow statement.
Examples of Leverage Ratios include:
- Debt-to-Equity
- Equity
- Debt
Efficiency
This is a useful ratio to monitor how an operation is performing in its asset and resource utilization.
Turnover Ratios fall into this category including:
- Accounts Receivable Turnover
- Accounts Receivable Days
- Asset Turnover Ratio
- Inventory Turnover
- Inventory Turnover Days
Liquidity
Financial analysts use this ratio to evaluate the company’s ability to meet its short and long-term debt obligations. This ratio helps to evaluate the risk factor when financial institutions are evaluating to offer credit to the company. This ratio can be broken down into three subcategories.
Asset Ratios include:
- Current Ratio
- Quick Ratio
- Cash Ratio
- Defensive Interval Ratio
Earnings Ratios include only one as per the ebook:
- Times Interest Earned Ratio
Cash Flow Ratios
- Times Interest Earned (Cash Basis) Ratio
- CAPEX to Operating Cash Ratio
- Operating Cash Flow Ratio
Valuation
These ratios are used to determine the overall value of a company. They fall into two brackets.
Price ratios:
- Price-to-Earnings Ratio
Enterprise Value Ratios:
- EV/EBITDA Ratio
- EV/EBIT Ratio
- EV/Revenue Ratio