The document discusses various types of financial ratios used to analyze corporate performance. It covers liquidity ratios, solvency ratios, activity/turnover ratios, profitability ratios, DuPont analysis, and valuation ratios. For each type of ratio, it provides the specific ratio calculation formulas and interpretations. The document is from a corporate finance course and is intended to serve as an overview guide of the key financial ratios analyzed.

1. C o r p o ra t e
F i n a n c e
C o u r s e
Valuation & Capital
Budgeting
Sum m er Sem ester
To p i c
Ju ly 04, 2022

2. So lven cy
Ratio s
Tu rn o ver/Ac
tiv ity Ratio s
Pro fitability
Ratio s
Du Po n t
An alysis
FINANCIAL RATIOS
 Liquidity Ratios
 Solvency Ratios
 Turnover / Activ ity / Efficiency Ratios
 Profitability Ratios
 DuPont Analysis
 Valuation Ratios
Fin an cial
Ratio s
Liq uidity
Ratio s
Valu atio n
Ratio s

3. FINANCIAL RATIOS
 Liquidity Ratios
The primary concern is the firm’s ability to pay its bills over the short run without
undue stress. Consequently, these ratios focus on current assets and current liabilities.
 C U R R E N T R AT I O : A measure of Short Term Liquidity
- Current Ratio = Current Assets / Current Liabilities
- Interpretation: Higher the Current Ratio, more LIQUID the balance sheet is
 Q U I C K R AT I O : Also a measure of Short Term Liquidity but a little more
conservative. It assumes only the assets that can be easily and relatively quickly
converted to liquidity (quick assets).
- Quick Ratio = [Current Assets – Inventory] / Current Liabilities
- Interpretation: Higher the Quick Ratio, more LIQUID the balance sheet is
 C A S H R AT I O : A highly conservative but most reliable measure of Liquidity.
- Cash Ratio = [Cash + Short Term Liquid Investments] / Current Liabilities
- Interpretation: Higher the Cash Ratio, more LIQUID the balance sheet is
So lven cy
Ratio s
Tu rn o ver/Ac
tiv ity Ratio s
Pro fitability
Ratio s
Du Po n t
An alysis
Fin an cial
Ratio s
Liq uidity
Ratio s
Valu atio n
Ratio s

4. FINANCIAL RATIOS
 Solvency Ratios
Solvency ratios provide information regarding the relative amount of debt in the
company’s capital structure and the adequacy of earnings and cash flow to cover
interest expenses and other fixed charges (such as lease or rental payments) as they
come due.
o Debt Ratios: focus on the balance sheet and measure the amount of debt capital
relative to equity capital.
o Coverage Ratios: focus on the income statement and measure theability of a
company to cover its debt payments.
 D E B T TO A S S E T S : Measures the percentage of total assets financed with debt.
- Debt to Assets Ratio = [ST Debt + LT Debt] / Total Assets
- Interpretation: higher debt means higher financial risk and thus weaker
solvency.
Solvency refers to a company’s ability to fulfill its long-term debt obligations.
So lven cy
Ratio s
Tu rn o ver/Ac
tiv ity Ratio s
Pro fitability
Ratio s
Du Po n t
An alysis
Fin an cial
Ratio s
Liq uidity
Ratio s
Valu atio n
Ratio s

5. FINANCIAL RATIOS
 Solvency Ratios
 D E B T TO C A P I TA L : Measures the percentage of total capital financed with
debt.
- Debt to Capital Ratio = [Total Debt + Shareholders’ Equity] / Total Assets
- Interpretation: higher debt means higher financial risk and thus weaker
solvency.
 D E B T TO E Q U I T Y: Shows the capital financing thru debt
- Debt to Equity Ratio = Total Debt / Shareholders’ Equity
- Interpretation: higher debt means higher financial risk and thus weaker
 F I N A N C I A L L E V E R A G E : Measures the amount of total assets supported for
each one money unit of equity.
- Financial Leverage Ratio = Avg. Total Assets / Avg. Shareholders’ Equity
- Interpretation: The higher the financial leverage ratio, the more leveraged
the company is in the sense of using debt and other liabilities to finance
assets.
So lven cy
Ratio s
Tu rn o ver/Ac
tiv ity Ratio s
Pro fitability
Ratio s
Du Po n t
An alysis
Fin an cial
Ratio s
Liq uidity
Ratio s
Valu atio n
Ratio s

6. FINANCIAL RATIOS
 Solvency Ratios
 I N T E R E S T C O V E R A G E R AT I O : measures the number of times a company’s
EBIT could cover its interest payments. Also referred to as ‘Times Interest
Earned’
- Interest Coverage Ratio = EBIT / Interest Expense
- Interpretation: A higher interest coverage ratio indicates stronger solvency,
offering greater assurance that the company can service its debt (i.e., bank
debt, bonds, notes) from operating earnings.
So lven cy
Ratio s
Tu rn o ver/Ac
tiv ity Ratio s
Pro fitability
Ratio s
Du Po n t
An alysis
Fin an cial
Ratio s
Liq uidity
Ratio s
Valu atio n
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7. FINANCIAL RATIOS
 Activ ity / Turnover Ratios
Also known as Asset Utilization or Operating Efficiency ratios.
It measures how well a company manages various activities, particularly how
efficiently it manages its various assets. Activity ratios are analyzed as indicators of
ongoing operational performance.
These ratios reflect the efficient management of both working capital and longer term
assets.
 C A S H C O N V E R S I O N C Y C L E : indicates the amount of time that elapses from
the point when a company invests in working capital until the point at which the
company collects cash.
- CCC = DOH + DSO – No. of Payable Days
- Interpretation: A shorter cash conversion cycle indicates greater liquidity.
 I N V E N TO RY T U R N O V E R : Indicates inventory management effectiveness.
- Inventory Turnover = COGS / Average Inventory
- Interpretation: Higher ITO implies inventory is held for a shorter period.
D AY S O F I N V E N TO RY O N H A N D : ITO in terms of # of Days
- DOH = 365 / ITO
So lven cy
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Tu rn o ver/Ac
tiv ity Ratio s
Pro fitability
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Du Po n t
An alysis
Fin an cial
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Liq uidity
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Valu atio n
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8. FINANCIAL RATIOS
 Activ ity / Turnover Ratios
 R E C E I VA B L E T U R N O V E R : Represents the elapsed time between a sale and
cash collection i.e. how fast company collects cash from customer.
- Receivable Turnover = Sales / Average Receivable
- Interpretation: A higher ratio might indicate highly efficient credit and
collection.
D AY S S A L E S O U T S TA N D I N G : RTO in terms of # of Days
- DSO = 365 / RTO
 PAYA B L E T U R N O V E R : measures how many times per year the company
theoretically pays off all its creditors.
- Payable Turnover = Purchases / Average Payable
- Interpretation: high (low days payable) relative to the industry could indicate
that the company is not making full use of available credit facilities
N O . O F D AY S O F PAYA B L E : PTO in terms of # of Days
- Days Payable = 365 / PTO
So lven cy
Ratio s
Tu rn o ver/Ac
tiv ity Ratio s
Pro fitability
Ratio s
Du Po n t
An alysis
Fin an cial
Ratio s
Liq uidity
Ratio s
Valu atio n
Ratio s

9. FINANCIAL RATIOS
 Profitability Ratios
Measure the company’s ability to generate profits from its resources.
 G R O S S P R O F I T M A R G I N :
- GPM = Gross Profit / Sales
 O P E R AT I N G P R O F I T M A R G I N :
- OPM = Operating Profit / Sales
 E B I T D A M A R G I N :
- EBITDA Margin = EBITDA / Sales
 E B I T M A R G I N :
- EBIT Margin = EBIT / Sales
 P R E TA X M A R G I N :
- Pre Tax Margin = Pre Tax Profit / Sales
 N E T M A R G I N :
- Net Margin = Profit After Tax / Sales
So lven cy
Ratio s
Tu rn o ver/Ac
tiv ity Ratio s
Pro fitability
Ratio s
Du Po n t
An alysis
Fin an cial
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Liq uidity
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Valu atio n
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10. FINANCIAL RATIOS
 Profitability Ratios
 R E T U R N O N A S S E T S : measures the return earned by a company on its assets
- ROA = Net Profit / Average Total Assets
- Interpretation: The higher the ratio, the more income is generated by a given
level of assets.
 R E T U R N O N E Q U I T Y: measures the return earned by a company on its Equity
Capital
- ROE = Net Profit / Average Total Equity
- Interpretation: The higher the ratio, the more income is generated by a given
level of equity.
 R E T U R N O N TO TA L C A P I TA L : measures the return earned by a company on
all of the employed capital
- ROCE = EBIT / [Average Total Debt + Average Total Equity]
- Interpretation: The higher the ratio, the more income is generated by a given
level of capital.
So lven cy
Ratio s
Tu rn o ver/Ac
tiv ity Ratio s
Pro fitability
Ratio s
Du Po n t
An alysis
Fin an cial
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Liq uidity
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Valu atio n
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11. FINANCIAL RATIOS
 DuPont Analysis
DuPont, a Chemical Company, developed the analysis in 1920s. In order to understand
the changes in ROE, they decomposed the ROE into various factors. They decomposed
the basic ROE calculation into 2 factor, 3 factor and 5 factor variations.
 B A S I C R E T U R N O N E Q U I T Y
R O E = N E T P R O F I T / AV E R A G E TO TA L E Q U I T Y
 M U LT I P LY A N D D I V I D E T H E F O R M U L A B Y AV E R A G E TO TA L A S S E T S
R O E = R O A * L E V E R A G E
[Step 2: Multiply and Divide the formula by Revenue]
 M U LT I P LY A N D D I V I D E T H E F O R M U L A B Y R E V E N U E
R O E = N E T P R O F I T M A R G I N * TO TA L A S S E T T U R N O V E R * L E V E R A G E
 M U LT I P LY A N D D I V I D E T H E F O R M U L A B Y E B T & E B I T
R O E = TA X B U R D E N * I N T E R E S T B U R D E N * E B I T M A R G I N * TO TA L
A S S E T T U R N O V E R * L E V E R A G E
So lven cy
Ratio s
Tu rn o ver/Ac
tiv ity Ratio s
Pro fitability
Ratio s
Du Po n t
An alysis
Fin an cial
Ratio s
Liq uidity
Ratio s
Valu atio n
Ratio s

12. FINANCIAL RATIOS
 Valuation Ratios
Valuation ratios measure the quantity of an asset or flow (e.g., earnings) associated
with ownership of a specified claim (e.g., a share or ownership of the enterprise).
 P R I C E TO E A R N I N G S : P/E ratio tells us how much an investor in common stock
pays per Rupee of earnings.
- P/E = Market Price / EPS
 P R I C E TO C A S H F L O W : An alternate to P/E.
- P/CF = Market Price / CFPS
 P R I C E TO S A L E S : used as a comparative price metric EPS is negative.
- P/S = Market Price / Sales PS
 P R I C E TO B O O K VA L U E :
- P/BV = Market Price / BVPS
 D I V I D E N D Y I E L D :
- DY = Dividend Per Share or DPS / Market Price
 R E T E N T I O N R AT I O :
- RR = 1 - Payout Ratio; where Payout Ratio = EPS - DPS
 S U S TA I N A B L E G R O W T H :
- g = ROE * RR
So lven cy
Ratio s
Tu rn o ver/Ac
tiv ity Ratio s
Pro fitability
Ratio s
Du Po n t
An alysis
Fin an cial
Ratio s
Liq uidity
Ratio s
Valu atio n
Ratio s