A ratio analysis transforms accounting numbers into meaningful ratios that highlight strengths and weaknesses of a business. This tool does not require a thorough understanding of accounting or finance to be used.

This tool will not make it easy to perform a ratio analysis, but a lot easier. From a whole day of computations by hand, you should be able to obtain 5 years of analysis within an hour, with understandable explanations, once familiar with the spreadsheet. One step is left to you to perform subsequently though: compare the results you obtained with the industry standards. Industry norms are available in public libraries or through specialized business information retailers, and distinguish among the type of industry and the size of the company. Enhanced tutorial (Javascript). Spreadsheet version "No spam" mailing list (subject: tools, message: subscribe) and bug reports: verte@aol.com

List of ratios

Liquidity Ratios	Profitability Ratios	Activity Ratios
Current Ratio Quick Ratio Inventory to Net Working Capital Cash Ratio	Gross Profit Margin Operating Margin Profit Margin Net Profit Margin Return On Investment Return on Equity Earnings Per Share	Inventory Turnover Days of Inventory Net Working Capital Turnover Asset Utilization Fixed Asset Turnover Accounts Receivable Turnover Average Collection Period Accounts Payable Period Days of Cash Productivity

Leverage Ratios	Other Ratios
Debt to Asset Ratio Long-term Debt to Capital Structure Times Interest Earned Coverage of Fixed Charges Leverage	Price/Earning Ratio Dividend Yield on Common Stock Dividend Payout Ratio Strategic_Cash_Flow Free Cash Flow Degree of Operating Leverage Index of Sustainable Growth Bankruptcy Index

• Why so many ratios ?
  Each ratio measures a company's performance with a limited angle. Only a combination of ratios will give you the big picture, revealing hidden but critical areas of concern.
  To save time however, you may concentrate on a few key strategic ratios which are highlighted below with a graphic.

Vocabulary

• Income Statement
  Also known as a profit and loss statement, it presents a company's profit performance for a period.
  It is typically arranged as follows.

  Sales
  (-) Discounts and Defective Returns
  (=) Net Sales
  (-) Cost of Goods Sold
  (=) Gross Profit
  (+) Other Income
  (-) Expenses (Marketing and Administrative)
  (=) Operating Profit
  (+/-) Currency exchange gains and losses
  (+/-) Gains or losses on sales of fixed assets
  (=) EBIT, ie Earnings Before Interest and Taxes
  (-) Interests
  (=) Pretax Profit (Earnings before taxes)
  (-) Taxes
  (=) Net Profit (Net Income)
  (-) Dividends
  (=) Retained Earnings

  
  

• Sales
  The term Sales throughout this site refers to Net Sales, that is: (Selling price x Quantities) - discounts and customer returns.
  

• Cost of Goods Sold (also known as Cost of Sales)
  The cost of goods sold is equal to:
  (The beginning inventory of finished goods - the ending inventory of finished goods) + the cost of the goods manufactured.
  Inventories are generally valued at cost or market price, whichever is lower.
  
• Balance Sheet
  The Balance Sheet lists what the company has (Assets) and what it owes (Liabilities and Equity). Assets and Liabilities are differentiated according to their short term (or Current) and long term (Long Term Liabilities or Fixed Assets) components. Main principle: total assets = total liabilities and equity.
  It is typically arranged as follows.

  Cash (+) (short term) Marketable securities (+) Accounts Receivable (+) Inventory (+) Other current assets (=) Total current assets (+) Land, building, equipment (-) Accumulated depreciation (=) Total Property, plants and equipment (+) Intangible assets (trademarks, goodwill) (+) Notes Receivable (loans granted) (long term) Marketable securities (=) Total Other assets = Total assets

  Overdrafts (+) Accounts payable (+) Accrued and deferred expenses (=) Total current liabilities (+) Notes Payable and long term debts (+) Pensions (retirement plans) = Total liabilities (+) Stocks (+/-) Retained earnings / losses (=) Total shareholders equity = Total liabilities and equity

  
  

Liquidity Ratios

Liquidity ratios measure the ability of a business to meet short term obligations.
• Current Ratio
  Measures the company's ability to pay its short-term liabilities from short-term assets.
  = Current Assets / Current Liabilities
  
• Quick Ratio
  Also known as Acid Test, measures the company's ability to pay off its short-term obligations from current assets, excluding inventories.
  = (current assets - inventory) / current liabilities
  It draws a more realistic picture of a company's ability to repay current obligations than the current ratio as it excludes inventories that may hardly be liquidated at their book value.
• Inventory to Net Working Capital
  Provides an idea of the danger of unfavorable changes in inventory to the excess of current assets over current liabilities.
  = Inventory / (current assets - current liabilities)
  
• Cash Ratio
  Measures the extent to which current obligations can be paid from cash or near cash assets.
  = (Cash and cash equivalents) / current liabilities
  

Activity Ratios

Activity ratios help assess the efficiency of managers' actions.
• Gross Profit Margin
  Margin available to cover other expenses beyond cost of goods sold.
  = (Sales - cost of goods sold) / net sales
  
• Operating Margin
  Margin available to cover interest costs, taxes and dividends.
  = Operating Income / net sales
  Operating Income is also known as profit from operations. Two noticeable examples of items that are non operation related are the "currency gains and losses" and the "profit or loss on sales of fixed assets."
  Currency gains and losses are related to sales made on credit in a foreign currency, which value changed between the time the sales took place and that of the payment receipt. Currency exposure of some companies is sizeable and poorly visible in company statements.
  The sales of fixed assets often misguide investors focusing on the bottom line only, as it may generate exceptional revenues which will not be repeated.
• Profit Margin
  Also known as Return on Sales, it shows how much before tax profit is generated for each dollar of sales.
  = Income before taxes / net sales
  
• Net Profit Margin
  Shows how much after tax profit (net income) are generated by each dollar of sales.
  = Net profit after taxes / net sales
  
• Return On Investment
  Also known as return on assets.
  = Net profit after taxes / total assets
  Before drawing any conclusion on this ratio, check for seasonal variability, and look at the quality of the assets used: are they bought or leased? Leased assets will deflate the amount of total assets and provide an impression of high return, while it generally costs more to a company in the long run to lease assets than to own them.
  
• Return on Equity
  Rate of return on the book value of the stockholders' investment.
  = Net profit after taxes (= net income) / stockholders' equity
  
• Earnings Per Share
  After tax earnings generated for each share of common stock.
  = (Net profit after taxes - preferred stock dividends) / number of shares
  
• Inventory Turnover
  Number of times the inventory was turned over (i.e., sold) during the period.
  = Net Sales / Average Inventory (see Days of inventory below)
  Too high a number means the inventory is rapidly sold. That could reveal a shortage of products therefore potential lost sales. Too low a number may reveal slow moving sales, hence an expensive inventory to finance and a potential depreciation (goods written off the accounts as if disposed of). Usually tough, it is related to a lenghthy production process with a lot of unfinished goods being stocked.
  A similar formula co-exists: Cost of goods sold / average inventory
• Days of Inventory
  Number of days's worth of inventory that a company has on hand.
  = Average Inventory / (cost of goods sold / statement's period)
  To lessen the seasonal aspect of a company's activity, the average inventory over the period should be used. Indeed, annual statements indicate the inventory level by year end. Therefore, the latest 12 months of inventory should be added then divided by 12.
  A similar formula co-exists: Average Inventory / (net sales / statement's period)
  
• Net Working Capital Turnover
  How well the net working capital (= current assets - current liabilities) is used to generate sales.
  = Net sales / net working capital (= Current Assets - Current Liabilities)
  
• Asset Utilization
  Or Asset Turnover, it measures the amount of sales generated by each dollar of asset.
  = Sales / total assets
  
• Fixed Asset Turnover
  Measures the utilization of the company's fixed assets.
  = Sales / fixed assets
  Typically, fixed assets are a combination of tangible assets (property, plants and equipment), intangible assets (trademarks, goodwill) and investments in subsidiaries.
  Conclusions should not be drawn solely on the numerical results of this ratio. Indeed for instance, consider the following cases where the sales volume is identical:
  -- Fixed assets may have been depreciated by a great extent, giving an impression of high return on assets.
  -- Assets are leased, hence the level of fixed assets is deflated, and an impression of high return on asset is provided. Look closely at the Coverage of Fixed Charges ratio in such cases.
  -- Recent investments were made that inflate the dollar volume of fixed assets, and give an impression of mismanagement.
  
• Accounts Receivable Turnover
  Number of times that accounts are cycled during the period.
  = Sales / Accounts Receivable (average)
  The average Accounts Receivable should preferably be taken into account.
  Indeed, to lessen the seasonal aspect of a company's activity, the average receivables over the period should be used. Annual statements indicate the receivables level by year end. Whenever possible though, the latest 12 months of receivable should be added then divided by 12.
• Average Collection Period
  Average length of time that a company must wait to collect a sale after making it. Does it fit the credit terms it offers?
  = Accounts receivable (average) / (sales / period of accounting statements)
  The average number of days to receive a payment greatly vary from one sector of activity to another, or from a country to another. A reasonable compromise is often negociated between the accounting department (which tends to lower the level of working capital, that is the need to finance assets, as well as the level of exposure to the risk of insolvency) and the sales department (which aims at increasing sales through better-than-market payment terms).
• Accounts Payable Period
  Average length of time that it takes the company to pay its suppliers.
  = Accounts payable / (purchases on credit/ period of accounting statements)
  Inportant note: The Cost of goods sold is used as an alternative to the amount of purchases.
  
• Days of Cash
  Number of days of cash on hand at present sales level.
  = Cash / (sales / period of time)
  
• Productivity
  Level of Sales per Employee.
  = Sales / Number of Employees
  Note that there are many other ways of measuring productivity.
  Also, when looking at the evolution of this criterium over time, inflation should be taken into account. Hence, you will be asked for the price index when selecting this ratio, and if at least two periods of data are entered, the Productivity at Constant Prices will be computed as follows:
  = (Sales / Price Index) / Number of Employees
  

Leverage Ratios

• Debt to Asset Ratio
  Measures the extent to which borrowed funds have been used to finance the acquisition of assets.
  = Total debt / assets
  Assets can be financed by available cash (purchase), debt (borrowing) or leases.
  Sometimes, management may yield to some objectives rather than a careful assessment (through a discounted cash flow analysis for example) of the long term benefit of one financing method over another. For instance, to better fulfill a target operating profit, a "$Managed By Objectives$" manager may favor leasing or borrowing over purchasing. Short term thinking !
• Long-term Debt to Capital Structure
  Measures the long-term component of the capital structure.
  = Long-term liabilities / stockholders' equity
  
• Times Interest Earned
  Also known as Coverage Ratio, it indicates the ability of the company to meet its interest costs.
  = Operating Profit / interest charges
  
• Coverage of Fixed Charges
  Company's ability to meet all of its fixed commitments.
  = (Profit before interest and taxes + lease charges) / (interest charges + lease charges)
  The lease charges being spread over several items of the Profit and Loss statement (hence the reason why it is added back into the EBIT), you may eventually find a summary of those as additional information in a company's annual statements.
• Leverage
  Measures the extent to which assets are financed with debt.
  = Assets / stockholders' equity
  The higher the leverage of a company, the greater the sensitivity of its profit to variations in sales volume. In other words, the more debt a company bears, the more likely it is to fail when sales go down, following a recession for instance.
  Note that for most financial institutions (banks), a leverage of up to 14 (7% equity, 93% debt) is considered normal. For manufacturing companies however, a leverage of up to 2 (50% equity) is normal. Check the industry standards for companies of similar size to the one you are studying.
  

Other Ratios

• Price/Earning Ratio
  Shows how much an investor is willing to pay for each dollar of earnings given the actual market price.
  = Market price per share / earnings per share
  This ratio usually evolves between 7 and 12 over time. Below 7 denotes either a bargain stock or one which recent news frighten the investors. Above 14 denotes either an overpriced stock or one which investors trust to have a great future.
  The average earnings per share over the past fews years should be used to compare several investment opportunities.
• Dividend Yield on Common Stock
  Dividend rate of return to stockholders at the current market price.
  = Dividend per share / market price per share
  
• Dividend Payout Ratio
  Percentage of profit that is paid out as dividend.
  = dividends per share / earnings per share
  
• Strategic Cash Flow
  This tool does not yet allow to compute this ratio.
  It is the cash left once internal growth has been financed. In other words, it is the cash left either to invest in strategic developments, or to distribute dividends, or to lower the debt load.
  = Cash flow + cash need variation + Capital expenditure, with
  Cash flow = Net income + depreciation, depletion and amortization,
  Cash need = Inventory + Receivables - Payables, the variation of which from one period to the other is computed,
  Capital expenditure = Tangible and intangible investments, the variation of fixed assets from one year to the other being an acceptable approximation.
  
• Free Cash Flow
  This tool does not yet allow to compute this ratio.
  Specialists in Leverage Buyouts (or takeovers) look at this amount in planning their strategy.
  = Cash flow - capital expenditures - dividends, with
  Cash flow = operating cash flow - interest expense - income tax expense,
  Dividends = dividends per share * number of shares.
  The difference between the levels of fixed assets over two periods is an approximation for Capital Expenditure.
  
• Degree of Operating Leverage
  This tool does not yet allow to compute this ratio.
  The Degree of Operating Leverage is the volume of sales, above the breakeven point, needed to earn a profit. This ratio varies with the level of sales.
  In other words, it shows how a percent change in sales volume will affect profit, at a specific level of sales. The higher the Degree of Operating Leverage, the greater the impact of a change in sales volume on profit.

  = Contribution Margin / Net Income, with
  Contribution Margin = Sales - Variable Costs

  You need first to be familiar with the concept of Variable Costs to determine the Contribution Margin. Then, you need to distinguish, in the Income Statement, among those costs that are variable and those that are not.
  

• Index of Sustainable Growth
  Developed by Robert L. Higgins, this index helps determine the level of growth of sales beyond which external capital will be needed. In other words, when planning for a specific growth in sales, one must be aware of whether external financing will be needed.

  g = (X1 (1 - X2) (1 + X3)) / (X4 - (X1 (1 - X2) (1 + X3))), with
  X1 = Profit Margin = (Income before Taxes / Sales) * 100
  X2 = Dividend Payout Ratio = Total Dividends / Net Income
  X3 = Leverage = Liabilities / Equity
  X4 = (Assets / Sales) * 100

  If sales growth forecast are above g:
  -- External financing (equity or debt) should be sought after,
  -- or the profit margin should be improved,
  -- or the distribution of dividends should be lower,
  -- or the level of assets should be lower (lease instead of buy).
  

• Bankruptcy Index
  Developed by Edward I. Altman on a sample of 66 manufacturing companies, it is a formula used to predict a company's likelihood of going bankrupt. The Z-score is reputed for becoming more accurate as a firm nears bankruptcy. As a general rule, a score below 1.81 is scarrying while a score above 2.99 is comfortable.
  Z = 1.2(X₁)+1.4(X₂)+3.3(X₃)+0.6(X₄)+1.0(X₅), with
  X1 = (Working capital = Current assets - Current Liabilities) / total assets
  X2 = Retained earnings / total assets
  X3 = EBIT / total assets
  X4 = (Market value of equity = Market Price per share * Number of stocks) / total debt
  X5 = Asset turnover = Sales / Total Assets
  

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