This document discusses various financial ratios used for ratio analysis. It defines ratios that measure liquidity, activity, leverage, and profitability. Common liquidity ratios include current ratio, quick ratio, and cash ratio. Activity ratios measure inventory turnover, receivables turnover, payables turnover, and asset efficiency. Leverage ratios compare debt to equity. Profitability ratios relate profits to sales, assets, and equity. Alternative ratios are also presented.

1. Ratio Analysis
Division of liabilities by veerabrahmam yata
Total funds/long term funds/capital employed/capital block
Equity/proprietary funds/net worth/intrinsic value
Total debt
/outsider
liabilities
Equity shareholders’
funds/pure equity
Preference
shareholders’ funds
Long term
debt
Short term
debt
(Reserves & surplus
– fictitious assets)
Equity share
capital
Preference
share capital
Secured loans Unsecured loans
Current
liabilitie
s
Share capital Fixed expense barred securities

2. Relation between Assets and Liabilities:
1. Share capital: 6. fixed assets including investments XXX
Equity capital XXX 7. Current assets XXX
Preference capital XXX 8. Fictitious assets XXX
2. Reserves and surplus XXX
3. Secured loans XXX
4. Unsecured loans XXX
5. Current liabilities XXX
TOTAL LAIBILITIES = TOTAL ASSETS
1+2-8 Equity 6 Fixed Assets
3+4+5 Out Sider Liabilities 7 Current Assets
EQUITY + OUT SIDER LIABILITY = FIXED ASSETS + CURRENT ASSETS
1+2-8 Equity 6 Fixed Assets
3+4 Long Term Debt 7-5 Working Capital
EQUITY + LONG TERM DEBT = FIXED ASSETS + WORKING CAPITAL
1+2+3+5-6-8 LONG TERM FUNDS-FIXED ASSETS =7-5 WORKING CAPITAL

3. Common Financial Ratios
Central to financial analysis is the calculation of financial ratios. A ratio has a numerator and a
denominator, which converts the financial data to a percentage. This provides one approach to
standardize financial information for useful comparisons. The major ratio categories and the questions
they attempt to answer are:
Liquidity Does the company have enough cash and current assets to pay obligations as
they come due?
Activity How efficient are the operations of the company?
Leverage What is the mix of equity to debt?
Performance How profitable is the company?
Common liquidity ratios are:
Ratio Calculation Discussion
Current Current Assets / Current
Liabilities
Standard ratio to evaluate working
capital.
Quick (Acid Test) (Cash + Marketable Securities +
Net Receivables) / Current
Liabilities
This ratio eliminates inventory and other
current assets from the denominator,
focusing on “near cash” and receivables.
Cash (Cash + Marketable Securities) /
Current Liabilities
Only cash and cash equivalents
considered for payment of current
liabilities.
Operating Cash Flow Cash Flows from Operations /
Current Liabilities
Evaluates cash-related performance (as
measured from the Statement of Cash
Flows) relative to current liabilities.

4. Common activity ratios are:
Ratio Ratio Discussion
Inventory Turnover COGS / Average
Inventory
Measures inventory management. Inventory
should be turned over rapidly, rather than
accumulating in warehouses.
Receivables Turnover Sales / Average
Accounts Receivables
Measures the effectiveness of credit policies and
needed level of receivables investment for sales.
(Also called the collection period).
Payables Turnover Sales / Average
Accounts Payables
Payables represent a financing source for
operations.
Working Capital
Turnover
Sales / Average Working
Capital
Measures how much working (operating) capital is
needed for sales.
Fixed Asset Turnover Sales / Average Fixed
Assets
Measures the efficiency of net fixed asset
(property, plant & equipment after accumulated
depreciation) investments.
Total Asset Turnover Sales / Average Total
Assets
Represents the overall (comprehensive) efficiency
of assets to sales.
Activity ratios can be converted to days “held,” measures that are easily compared across firms:
Ratio Calculation
Average Days Inventory in Stock 365 / Inventory Turnover
Average Days Receivables Outstanding 365 / Receivables Turnover
Average Days Payable Outstanding 365 / Payables Turnover
Length of Operating Cycle 365 [(1 / Inventory Turnover) +
(1 / Receivables Turnover)] ; equivalent to average
days inventory + average days receivables
outstanding

5. Common leverage ratios are:
Ratio Calculation Discussion
Debt to Equity Total Liabilities / Total
Stockholders’ Equity
Direct comparison of debt to equity
stakeholders and the most common
measure of capital structure.
Debt Ratio Total Liabilities / Total Assets A broader definition, stating debt as a
percent of assets.
Interest Coverage
(Times Interest Earned)
(Net Income + Interest
Expense + Tax Expense) /
Interest Expense
This is a direct measure of the firm’s ability
to meet interest payments, indicating the
protection provided from current
operations.
Long-term Debt to
Equity
Long-term Liabilities / Total
Stockholders’ Equity
A long-term perspective of debt and equity
positions of stakeholders
Debt to Market Equity Total Liabilities at Book Value
/ Total Equity at Market Value
Market valuation may represent a better
measure of equity than book value. Most
firms have a market premium relative to
book value.

6. Common profitability ratios are:
Ratio Calculation Discussion
Gross Margin (Sales – COGS) / Sales This captures the relationship between
sales and manufacturing (or
merchandising) costs. (Also, called the
gross profit margin.)
Return on Sales Net Income / Sales Measures the relationship of the bottom
line to sales and thus captures sales to
total costs of sales. (Also called the net
profit margin).
Return on Assets Net Income / Average Total
Assets
Measures the firm’s efficiency in using
assets to generate earnings. Alternatively
stated, it captures earnings to all
providers of capital
Pretax Return on Assets Earnings Before Interest &
Taxes / Average Total Assets
Measures earnings from operations on a
pretax and pre-interest expense basis.
Return on Total Equity Net Income / Average Total
Stockholders’ Equity
Measures earnings to owners as
measured by net assets.
Dividend Payout Common Dividends / Net
Income
Measures the percent of earnings paid
out to common stockholders.

7. Below are some alternative ratios:
Liquidity
Cash to Current Assets (Cash + Marketable Securities) / Current Assets
Cash Position Cash / Total Assets
Current Liability Position Current Liabilities / Total Assets
Leverage
Bonded Debt to Equity Bonded Debt / Stockholders’ Equity
Debt to Tangible Net Worth Total Liabilities / (Common Equity – Intangible Assets)
Activity
Cash Turnover Sales / Average Cash (which usually includes marketable securities)
Payables Turnover Sales / Average Accounts Payable
Profit
Operating Profit Margin Income From Continuing Operations (After Tax) / Sales
Pretax Profit Margin Income Before Tax / Sales
Return on Common Equity (Net Income – Preferred Dividends) / Average Common Equity
Financial Leverage Index Return on Equity / Return on Assets