Financial Ratio Analysis with Explanation

Published on Thursday, December 18, 2014
Today list all the Financial ratios with explanation. These ratios are important for general awareness section as well as for interviews
  1. Profitability Ratios, 
  2. Leverage Ratios, 
  3. Turnover Ratios and 
  4. Liquidity Ratios

Must read for Inteview Preparations

Profitability Ratios

There are 5 basic Profitability Ratios/ Margins:

Gross Profit Ratio/ Margin:

  • The formula is = (Gross Profit/ Net Sales) x 100
  • Gross profit means the Sales – Expenses directly related to the business.
  • Net Sales is Total Sales – any sales returns.
  • It is a very basic ratio to show how a business is performing – it is the most basic profit showing ratio.

Net Profit Ratio/ Margin: 

  • The formula is = (Net income/ Net Sales) x 100
  • Net Income means – pure business income leaving out ‘other income’ like income from savings bank/ FDs/ Investment etc. This is the income from carrying out the business.

Return on Asset :

  • The formula is = Net income/ Average Assets
  • It shows how effectively a company is utilizing its assets to earn profits.

Return on Investment:

  • The formula is = Net income/ Long Term Capital
  • Long term capital includes long term liabilities – like Debentures/ Loan and Capital,
  • It shows how much the firm is able to earn in respect of its long term liabilities. Liabilities are obligations of a company.

Return on Equity:

  • The formula is = Net income/ Equity
  • Equity is Shareholder’s Funds = Equity Share Capital and Reserves and Surplus. It is the company’s owner’s funds.


There are 4 basic Leverage Ratios:

Total Assets to Debt Ratio:

  • The formula is = Total Liabilities/Total Assets
  • .Shows that is times become hard and liabilities need to paid off – then the company has enough assets to cover the liabilities.

Debt to Equity Ratio:

  • The formula is = Total Liabilities/Equity
  • It shows the coverage of liabilities of a company with regards to company’s equity.

Interest Coverage Ratio:

  • The formula is = EBIT/Interest Obligations
  • EBIT = Earnings before Interest and Taxes.
  • Interest Obligations are the interest you need to pay on loans/ debentures etc.
  • It measures a firm’s ability to pay its interest obligations.

Long term debt to Net Working Capital ratio:

  • The formula is = Total long term debt/Net WC
  • Net WC = Net Working Capital = Current Assets – Current Liabilities.
  • It measure the capacity of firm to meet long term debt obligations after meeting current liability obligations from the current assets. 

Tunrover Ratios

There are 6 basic Turnover Ratios:

Cash Turnover Ratio:

  • The formula is = Net Sales/ Cash
  • Shows how effectively cash is being utilized.

Fixed Assets Turnover Ratio:

  • The formula is = Net sales/ Net fixed assets
  • Shows the utilization of fixed assets to generate sales.

Assets Turnover Ratio:

    • The formula is = Net Sales/Average Total Assets
    • This is another asset ratio which measures net sales against the total assets.

    Receivables Turnover Ratio:

    • The formula is = Net Sales/Average Receivables
    •  Receivables are the Accounts Receivables, which include debtors/bills receivables etc.
    • This shows how much of sales is made in credit and hence the liquidity position of the firm as funds are held up in the form of ‘receivables’.

    Payables Turnover Ratio:

    • The formula is = Net Purchases/Average Payables
    • Average payables are the accounts payables or the firm’s current liabilities to creditors.
    • It shows how much of purchases is made on credit and the ratio payment liquidity.

    Inventory Turnover Ratio:

    • The formula is = Cost of the Goods Sold/ Average Inventory
    • Average Inventory is the Stock-in-Trade.
    • This ratio shows the liquidity of inventory.

    Liquidity Ratios

    Current ratio

    • The formula is = Current Assets/ Current Liabilities

    Acid test ratios

    • Formula is = Quick Assets/ Current Liabilities

    Working Capital Ratio:

    • Working capital = Current Assets – Current Liabilities
    • Working Capital Ratio = Current Assets/Current Liabilities

    Cash Ratio:

    • Formula = Cash + Marketable Securities/ Current Liabilities

    That is all folks on the Financial Ratios front. Commerce or non-Commerce these are the basic ratios and they will ask from these – you are expected to know these for sure.

    For commerce students things can go into more details such as what will be included in EBIT etc.

    But basic purpose these are a must know!

    So keep the preps going on in full steam…and have a fruitful day!

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