What are the 10 financial ratios?
The term “financial ratios” can be confusing to some people. A ratio simply compares two numbers to each other. It’s a way of standardizing data to be more easily interpreted. Financial ratios are used in various settings, from personal finance to investment analysis. There are all sorts of financial ratios, but we’re going to focus on ten of the most important ones. These ratios will give a good idea of a company’s financial health and whether or not it’s a good investment.
1. Price to Earnings Ratio (P/E)
One of the most common financial ratios is the Price to Earnings Ratio (P/E). This Ratio measures the relationship between a company’s stock price and its earnings per share.
P/E ratios can be used to compare companies in the same industry, sector, or across different industries. A high P/E ratio may indicate that a company’s stock price is higher relative to its earnings, which could mean the stock is overvalued. Conversely, a low P/E ratio could indicate that a company’s stock price is low relative to its earnings, which could mean the stock is undervalued.
P/E ratios are just one tool that investors can use to evaluate companies. It’s important to remember that no single ratio should be used in isolation; rather, ratios should be considered in conjunction with other information about a company to get a comprehensive picture of its financial health and investment potential.
2. Price Earnings Growth Ratio (PEG)
The Price to Earnings Growth Ratio (PEG) measures a company’s future earnings growth. It is calculated by dividing the price/earnings ratio by the company’s growth rate. A high PEG ratio indicates that a company’s stock price is high relative to its earnings growth rate. This may be due to expectations of high future earnings growth or high current stock prices. A low PEG ratio indicates that a company’s stock price is low relative to its earnings growth rate. This may be due to expectations of low future earnings growth or low current stock prices.
3. Price to Book Ratio (P/B)
P/B is a company’s stock price ratio to its book value. It is calculated by dividing the stock’s price per share compared to the book value per share.
A high P/B ratio may indicate that a stock is overvalued, while a low P/B ratio may indicate that a stock is undervalued. However, several other factors should be considered before making an investment.
4. Return on Assets (RoA)
Several different financial ratios can be used to evaluate a company’s financial health, but one of the most important is the return on assets (RoA) ratio. This Ratio measures how much profit/cash a company generates for every dollar of assets it owns and is a good way to gauge how efficient the company is at using its resources to generate income. A high ROA ratio indicates a company is generating a lot of profit for each dollar of its assets, while a low RoA ratio suggests that the company could be doing more with what it has.
To calculate the RoA ratio, simply divide a company’s net income by its total assets. For example, if Company A has a net income of $10 million and total assets of $100 million, its RoA ratio would be 10%. While there’s no magic number that all companies should aim for, generally, a higher RoA is better than a lower one. That being said, it’s important to remember that this Ratio can be affected by several factors, such as the industry a company operates in and the amount of debt it has. As such, it’s always best to compare a company’s ROA to its peers before drawing any conclusions.
5. Profit Margin
Profit margin is a financial ratio that measures the percentage of profit a company generates from its total revenue. Profit margin is also known as “net profit margin” or “net margin.” A company’s profit margin can be affected by factors, including the cost of goods sold, operating expenses, and taxes. A company with a high-profit margin is usually more efficient and profitable than a low-profit margin. There are several different profit margins, including net profit, operating profit, and gross profit margin.
Gross profit margin is the percentage of revenue that remains after the cost of goods sold has been deducted. The operating profit margin is the percentage of revenue that is left after all operating expenses have been deducted. Net profit margin is the percentage of revenue left after all expenses have been deducted. Company profit margins can vary depending on the industry it operates. For example, companies in the retail selling industry typically have lower profit margins than companies in the technology industry.
6. Current Ratio
The current Ratio is a financial ratio that measures a company’s solvency. It is calculated by dividing the company’s current assets with its current liabilities. A high current ratio shows that a company can pay its short-term obligations. A low current ratio shows that a company is having difficulty paying its short-term obligations.
7. Quick Ratio
The quick Ratio is a ratio that measures the company’s ability to pay its short-term liabilities with its quick assets. Quick assets are defined as cash, marketable securities, and accounts receivable. The quick Ratio is calculated by dividing a company’s quick assets by its current liabilities.
A high quick ratio shows that a company has enough liquid assets to pay for its short-term liabilities. A low quick ratio shows that a company does not have enough liquid assets to cover its short-term liabilities. The ideal quick Ratio is 1, which means that a company has exactly enough liquid assets to cover its short-term liabilities.
8. Debt-to-Equity Ratio
The debt-to-equity Ratio is a financial ratio that measures the relative proportion of ownership and borrowed funds in a company. A higher debt-to-equity ratio shows that a company has been financed more by debt than equity, which may make it riskier.
The debt-to-equity Ratio is calculated by dividing a company’s total liabilities by its shareholder equity. The total liabilities figure includes both short-term and long-term debt. Shareholder equity equals a company’s total assets minus its total liabilities.
A company with a high debt-to-equity ratio may be more leveraged, meaning it has borrowed more money to finance its operations than it has raised from shareholders. This can make the company riskier since it may have difficulty meeting its financial obligations if business conditions turn unfavorable.
However, it’s important to remember that not all debt is equal. Some types of debt, such as loans from banks or other lenders, may be less risky than others, such as bonds issued to the public. And some companies may be able to manage their debt load effectively even if they have a high debt-to-equity ratio.
9. Asset Turnover Ratio
The asset turnover ratio is a ratio that measures how efficiently a company uses its assets. The formula for asset turnover ratio is as follows:
Asset Turnover Ratio = Sales ÷ Average Total Assets
The asset turnover ratio is used to see the efficiency of a company’s asset investment and compare the efficiency of different companies. A high asset turnover ratio shows that a company uses its assets efficiently to generate sales. A low asset turnover ratio shows that a company is not using its assets efficiently.
10. Inventory Turnover Ratio
The inventory turnover ratio measures how long a company sells its inventory. The higher the Ratio, the faster the company is selling its inventory. The formula for this Ratio is:
Inventory turnover ratio = (sales/inventory)
For example, if a company has above $1 million in sales and $500,000 in inventory, its inventory turnover ratio would be 2. This means that, on average, the company sells its entire inventory every two weeks.
This Ratio is important because it shows how efficient a company is at selling its products. A high turnover ratio means the company sells its products quickly and efficiently. A low turnover ratio could indicate that the company is not selling its products as quickly as possible.