This document defines and provides explanations for 14 common financial ratios used to analyze companies. It explains what each ratio measures and why it is important. For example, it states that the current ratio measures a company's ability to pay short-term debts and ratios under 1 indicate inability to pay liabilities. The return on capital employed ratio measures profitability and efficiency of capital use, with higher ratios being better. It also provides guidelines for interpreting the ratios, such as wanting an interest coverage ratio above 1.5.

1. 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

2. 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?