Financial Ratios Glossary


Cash Flow-Solvency Ratios

Accounts Payable: Income: Accounts Payable divided by Annual Income, measuring the speed with which a company pays vendors relative to Income. Numbers higher than typical industry ratios suggest that the company may be using suppliers to float operations.

Current Liabilities: Inventory: Current Liabilities divided by Inventory: A high ratio, relative to industry norms, suggests over-reliance on unsold goods to finance operations.

Current Liabilities: Net Worth: Current Liabilities divided by Net Worth, reflecting a level of security for creditors. The larger the ratio relative to industry norms, the less security there is for creditors.

Current Ratio: This is the same as Current Assets divided by Current Liabilities, measuring current assets available to cover current liabilities, a test of near-term solvency. The ratio indicates to what extent cash on hand and disposable assets are enough to pay off near term liabilities. The Quick Ratio is applied as a more stringent test.

Days Payables: 365/(Cost of Sales: Accounts Payable ratio): Reflects the average number of days for each payable before payment is made.

Quick Ratio: Cash plus Accounts Receivable, divided by Current Liabilities, indicating liquid assets available to cover current debt. Also known as the Acid Ratio. This is a harsher version of the Current Ratio, which balances short-term liabilities against cash and liquid instruments.

Total Liabilities: Net Worth: Total liabilities divided by Net Worth. This ratio helps to clarify the impact of long-term debt, which can be seen by comparing this ratio with Current Liabilities: Net Worth. Creditors are concerned to the extent that total liability levels exceed Net Worth.

 

Profitability Ratios

EBITDA: EBITDA: Income: Earnings Before Interest, (income) Taxes due, Depreciation and Amortization divided by Income. EBITDA: Income is a relatively controversial (and often criticized) metric designed to eliminate the effect of finance and accounting decisions when comparing companies and industry benchmarks. Tax credits and deferral procedures and non-cash expenditures (Amortization and Depreciation) are not deducted from the profit equation, as are interest expenditures.

Return on Assets: Pre-Tax or After Tax Net Profit divided by Total Assets, a critical indicator of profitability. Companies which use their assets efficiently will tend to show a ratio higher than the industry norm. The ratio may appear higher for small businesses due to owner compensation draws accounted as net profit.

Return on Net Worth: Pre-Tax or After Tax Net Profit divided by Net Worth. This is the 'final measure' of profitability to evaluate overall return. This ratio measures return relative to investment, how well a company leverages the investment in it. May appear higher for small businesses due to owner compensation draws accounted as net profit.

Return on Income: Pre-Tax or After Tax Net Profit Net Profit divided by Annual Income, indicating the level of profit from each dollar of Income. This ratio can be used as a predictor of the company's ability to withstand changes in prices or market conditions. May appear higher for small businesses due to owner compensation draws accounted as net profit.

 

Efficiency-Debt-Risk Ratios

Assets: Income: Total Assets divided by Net Income, indicating whether a company is handling too high a volume of Income in relation to investment. Very low percentages relative to industry norms might indicate overly conservative sales efforts or poor sales management.

Cost of Sales:Accounts Payable: Measures the number of times payables turn over in the course of the year. High measures may indicate cash flow concerns.
Cost of Sales: Inventory: Reflects the number of times inventory is turned over during the course of the year. High levels can mean good liquidity or Income, or shortages requiring better management. Low levels may indicate poor cash flow or overstocking.

Days Inventory: 365/(Cost of Sales: Inventory): The average number of days of items in inventory.

Days Receivables: 365/ (Receivables Turnover): Reflects the number of days that receivables are outstanding. Target average or lower.

Days Working Capital: 365/ (Working Capital Turnover): Expresses the coverage in number of days of available working capital.

EBITDA: interest expense: Earnings before Interest, (income) Taxes due, Depreciation and Amortization divided by Interest expense. Assesses financial stability by examining whether a company is at least profitable enough to pay interest expense. A ratio >1.00 indicates it is. See cautions in the listing for EBITDA.

Fixed Assets: Net Worth: Fixed Assets divided by Net Worth. High ratios relative to the industry can indicate low working capital or high levels of debt.

Gross Margin: Income: Pre-tax profits divided by Annual Income. This is the profit ratio before product and Income costs, as well as taxes. This ratio can indicate the "play" in other expenses which could be adjusted to increase the Net Profit margin.

Net Working Capital: Income: Net Working Capital divided by Income. Indicates if a company is maintaining a reasonable level of liquidity relative to its Income volume. A high ratio indicate an overly conservative reliance on liquid assets, while low ratios suggests the opposite.

Loans/Notes Payable:Net Worth: The Loans/Notes Payable portion of current liabilities divided by Net Worth, a measure of debt coverage.

Long-Term Liabilities:Net Worth: Long-Term Liabilities divided by Net Worth, a measure of debt coverage.

 

Turnover Ratios

Cash Turnover: Income divided by Cash. Indicates efficiency in the use of cash to develop Income . A more stringent ratio than Working Capital Turnover (below). Target at or slightly below industry level.

Current Asset Turnover: Income divided by Current Assets. A general indicator of the efficiency of asset use. Target at or slightly below industry level.

Fixed Asset Turnover: Income divided by Fixed Assets. An indicator of the efficiency of investment in fixed asset such as plant and equipment. Target at or slightly below industry level.

Inventory Turnover: Income divided by Inventory. This ratio gives a picture of how quickly inventory turns over. Ratios below the industry norm suggest high levels of inventory. High ratios could indicate product levels insufficient to satisfy demand in a timely manner. Target: at or slightly above industry level.

Receivables Turnover: Income divided by Receivables. An indicator of how efficiently invoiced sales are collected. Target at or slightly above industry level.

Total Asset Turnover: Income divided by Total Assets. Target: at or slightly below industry level.

Working Capital Turnover: Income divided by Net Working Capital (current assets minus current liabilities). Ratios higher than industry norms may indicate a strain on available liquid assets, while low ratios may suggest too much liquidity. Target at or above industry level.

 

 



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