Financial Ratios

Financial Ratio Formula Why is it used?

Current Ratio Current assets : current liabilites Whether the company has enough resources to pay back its liabilites. The higher the current ratio, the more capable the company in paying its liabilites.Ratio of 1 indicates company's inability to pay off liabilities.

Acid Test Ratio Liquid assets : current liabilites Whether a firm has enough short-term assets to cover its immediate liabilites without selling inventory.Companies with ratios of less than 1 cannot pay their current liabilities and should be looked at with extreme caution.

ROCE% ( Net profit / capital employed ) * 100 A financial ratio that measures a company's profitability and the efficiency with which its capital is employed. A higher ROCE indicates more efficient use of capital. ROCE should be higher than the company’s capital cost; otherwise it indicates that the company is not employing its capital effectively and is not generating shareholder value.

Asset turnover Revenue / net assets The amount of sales or revenues generated per dollar of assets. Generally speaking, the higher the ratio, the better it is, since it implies the company is generating more revenues per dollar of assets.

Inventory turnover

CGS / inventories The no. of times a stock is bought & resold in the market.

Interest cover ratio

Operating profits / interest paid No. of times the current interest charges can be paid out of current operating profit.A ratio under 1 means that the company is having problems generating enough cash flow to pay its interest expenses.Ideally you want the ratio to be over 1.5.

Receivables ( Receivables / revenue ) * 365 How long a business takes to recover its debts.A high ratio implies either that a company operates on a cash basis or that its extension of credit and collection of accounts receivable is efficient.

A low ratio implies the company should re-assess its credit policies in order to ensure the timely

collection of imparted credit that is not earning interest for the firm.

Gearing ( Non-current liabilites / capital employed ) * 100

How much capital is financed from long-term loans.The higher a company's degree of leverage, the more the company is considered risky.

Dividend per share

Total dividends / no. of shares How much dividend is earned per share.

Dividend yield ( Dividend / share market price) * 100 Rate of return a shareholder gets at the current share price.Dividend yield is a way to measure how much cash flow you are getting for each dollar invested in an equity position

Dividend cover ratio

Profit after tax & interest / annual dividends No. of times ordinary share dividend could be paid out of current profits.A healthy company will have a high coverage ratio, indicating that it has little difficulty in paying off its preferred dividend requirements. Not only does this ratio give investors an idea of a company's ability to pay off its preferred dividend requirements, but it also gives common shareholders an idea of how likely they are to be paid dividends.

Price earning ratio

Share market price / total earning per share Whether to invest in business or not?