This document provides descriptions and explanations of various types of financial ratios used in ratio analysis. It discusses liquidity ratios like the current ratio and quick ratio, profitability ratios such as return on assets and return on equity, activity ratios including asset turnover and inventory turnover, capital structure ratios like the debt ratio, and market ratios like the price to earnings ratio. It also covers DuPont analysis, analysis of leverage, and sustainable growth rate. The ratios can be used to evaluate different aspects of a company's financial health and performance over time.

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Financial Statement Analysis
Analysis can be made in many ways. Financial Ratios can be used to understand and
measure how well a company is doing in an area. Ratios can be used to compare one
company against another, or one time period against another. Common size statements
are used to compare different companies, as each line item is expressed as a ratio of
another, and therefore can be used for accurate comparison against different sized
companies. Trend analysis is helpful to understand the change in a company’s financial
statements from one period to another.
Liquidity Ratios
The Current Ratio is used to test the company's ability to pay its short term obligations.
Below 1 means the company does not have sufficient incoming cash flow to meet its
obligations over the coming year.
The Quick Ratio is an indicator of a company's short­term liquidity. The quick ratio
measures a company's ability to meet its short­term obligations with its most liquid assets.
The higher the quick ratio, the better the position of the company.
Profitability Ratios
Return on Assets is an indicator of how profitable a company is relative to its total assets.
ROA gives an idea as to how efficient management is at using its assets to generate
earnings.
Return on Equity provides the amount of net income returned as a percentage of
shareholders equity. Return on equity measures a corporation's profitability by revealing
how much profit a company generates with the money shareholders have invested.

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The Return on Invested Capital measure gives a sense of how well a company is using its
money to generate returns. Comparing a company's return on capital (ROIC) with its cost
of capital (WACC) reveals whether invested capital was used effectively.
Return on Common Equity measures a corporation's profitability by revealing how much
profit a company generates with the money shareholders have invested.
Gross Profit Margin (Gross Margin) is used to assess a firm's financial health by revealing the
proportion of money left over from revenues after accounting for the cost of goods sold.
Profit Margin is used to determine the profitability of each dollar of sales that company
makes.
Operating Margin shows the profitability of the ongoing operations of the company,
before financing expenses and taxes.
Earnings Per Share is the portion of a company's profit allocated to each outstanding
share of common stock.
Activity Analysis
Asset Turnover measures a firm's efficiency at using its assets to generate sales revenue,
the higher the better.

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Accounts Receivable Turnover is used to quantify a firm's effectiveness in extending credit
as well as collecting debts. The receivables turnover ratio is an activity ratio, measuring
how efficiently a firm uses its assets.
Days Receivables indicates the average number of days that receivables are
outstanding. High numbers indicate long collection periods, low numbers indicate
efficient collection of receivables.
Average Days Sales
Inventory Turnover measures how many times a company's inventory will be sold and
replaced in a year.
Inventory Turnover Period in Days measures how many days it takes for a company to
turnover its entire inventory.
Fixed Asset Turnover measures the efficiency of fixed assets to generate profit. The higher
the number, the more efficient management’s use of fixed assets.
Working Capital Turnover measures the depletion of working capital to the generation of
sales over a given period. This provides some useful information as to how effectively a

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company is using its working capital to generate sales.
Capital Structure Analysis
The Debt Ratio indicates what proportion of debt a company has relative to its assets. The
measure gives an idea to the leverage of the company along with the potential risks the
company faces in terms of its debt­load.
The Debt to Equity Ratio is a measure of a company's financial leverage. It indicates what
proportion of equity and debt the company is using to finance its assets.
The Debt to Tangible Net Worth Ratio is a measure of a company's financial leverage to
the tangible asset value of owner's equity. It indicates what proportion of equity and debt
the company is using to finance its tangible assets.
Times Interest Earned is used to measure a company's ability to meet its debt obligations.
Failing to meet these obligations could force a company into bankruptcy.
Debt Servicing Ratio is used to assess a company’s ability to meet all of its debt repayment
obligations, both interest and principal repayments.
Market Analysis
The Price to Earnings Ratio tells us how many years it will take for earnings to repay the
current market share price. This is a useful measure to compare companies in the same

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industry.
The Dividend Yield shows how much a company pays out in dividends each year relative
to its share price. In the absence of any capital gains, the dividend yield is the return on
investment for a stock.
The Dividend Payout Ratio is the percentage of earnings that are paid out to
shareholders. Earnings not paid to shareholders are expected to be retained by the
company and invested in further operations.
Price to Book Ratio tells us the relative value the market places on the company to the
accounting valuation. This ratio provides a basic understanding of residual value of a
company should it go bankrupt.
Earnings Per Share is the portion of a company's profit allocated to each outstanding
share of common stock.
DuPont Analysis
Du Pont Analysis is used to identify the components of business operations that lead to
shareholders return. Total return on equity is the profitability, multiplied by the rate of asset
turnover, multiplied by the ratio of assets to equity (leverage). By identifying each
component and evaluating, strength and weakness can be evaluated, as well as insight
into competitive advantage. Understanding how each element leads to return on equity
will help a researcher investigate further into the operations of a company.

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Profit Margin is used to determine the profitability of each dollar of sales that company
makes.
Asset Turnover measures a firm's efficiency at using its assets to generate sales revenue,
the higher the better.
Leverage of Assets measures the ratio between assets and owner's equity of a company.
The higher the number, the higher the leverage.
Analysis of Leverage
Analysis of Leverage is used to evaluate how effectively management is using borrowed
funds to make a return for income. Typically, funds are raised by debt in order to enhance
the return to shareholders. This is done by financing the company’s assets with debt,
which requires a fixed payment of interest. If the assets financed by debt generate pretax
net income sufficient to repay this interest, then any additional net income is profit that
goes to the shareholders.
A company’s assets can be divided into assets funded by equity, and assets funded by
debt. It is possible to analyze the efficiency with which a company’s assets generate
pretax income, and allocate this income in proportion to the capital structure. We can
then determine the amount that each set of assets contributes to net income. We would
expect that management would be able to use assets financed by debt to generate
enough net income to pay the borrowing costs, and hopefully produce additional
income for the shareholders. If the income generated by the borrowed assets is negative,
then it may be advisable for a company to alter its capital structure, or focus on improving
the efficiency of its assets in regards to generating net income.
Gross Efficiency of Assets tells us how much income each dollar of assets generates
before paying out taxes and interest. This tells us how efficiently management uses its
assets.

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Pretax Income is a made up of two sources, income from assets funded by shareholders
equity, and assets funded by borrowed debt.
Income from Unleveraged Assets is the income generated by the assets funded by
shareholders equity and operations.
Income from Leveraged Assets is the income generated by assets funded by borrowed
debt.
Leveraged Assets Contribution to NI is the percentage of the pretax income that is
provided by management’s use of debt to fund assets. Higher numbers show good use of
debt. Negative number show losses generated by the assets financed by debt.
Sustainable Growth Rate
Sustainable Growth Rate is the maximum growth rate of a company if none of its ratios
change and it does not raise new capital through selling shares.