FINANCIAL RATIOS AND THEIR INTERPRETATION

Different Financial Ratios

Sl.No. CATEGORY TYPES OF RATIO INTERPRETATION

Net Working Capital =  It measures the liquidity of a firm.

Current assets-current liabilities

1. Liquidity ratios
 It measures the short term liquidity of
Current ratio = a firm. A firm with a higher ratio has
better liquidity.
Current Assets
Current Liabilities  A ratio of 2:1 is considered safe.

Acid test or Quick ratio =  It measures the liquidity position of a

firm .
Quick assets
Current Liabilities  A ratio of 1:1 is considered safe.

Inventory Turnover ratio =  This ratio indicates how fast

inventory is sold.
Turnover ratios Cost of goods sold
2.
Average  A firm with a higher ratio has better
inventory
liquidity.

Debtor Turnover ratio =  This ratio measures how fast debts

are collected.
Net credit sales
Average debtors
 A high credit
between sales andshorter
ratio indicates cash time lag
collection.

Creditor’s Turnover ratio =  A high ratio shows that accounts are

to be settled rapidly.
Net credit
purchases
Average Creditors
Sl. CATEGORY TYPES OF RATIO INTERPRETATION
No.
 This ratio indicates the
Debt-Equity ratio = relative proportions of debt
3. Capital and equity in financing the
Structure Ratios Long term debt assets of a firm.
’
Shareholder s Equity
 A ratio of 1:1 is
considered safe.

 It indicates what
Debt to Total capital ratio = proportion of the
permanent capital of a
Long term debt firm consists of long-term
Permanent debt.
Capital

 A ratio 1:2 is considered

safe.

Or

Total debt  It measures the share of

Permanent capital + Current
liabilities the total assets financed
by outside funds.

 A low ratio is desirable

for creditors.

Or
′
Total Shareholder s Equity  It shows what portion of
Total Assets the total assets is financed
by the owners’ capital.

 A firm should neither

have a high ratio nor a
low ratio.
Sl.No. CATEGORY TYPES OF RATIO INTERPRETATION

Interest Coverage =  A ratio used to determine

how easily a company can
4. Coverage Earning before Interests and Tax Pay on outstanding debt.
ratios Interest  A ratio of more than 1.5 is

Satisfactory.

Dividend Coverage =  It measures the ability of

firm to pay dividend on
Earning after tax Preference shares.
Preference Dividend

Creditors.

 A high ratio is better for

Total Coverage ratio =  It shows the overall ability

Earning before interests and tax
Total &ixed charges
of the firm to fulfill the
liabilities.
 A high ratio indicates better
ability.
Sl. No. CATEGORY TYPES OF RATIO INTERPRETATION

 It measures the profit in

5. Profitability Gross Profit margin = relation to sales.
ratios
Gross profit ∗ 100  A firm should neither have
Sales a high ratio nor a low ratio.

Net Profit margin =

 It measures the net profit of
Net Profit after tax before interest a firm with respect to sale.
Sales

Or  A firm should neither have

a high ratio nor a low ratio.
Net Profit after Tax and Interest
Sales

Or
Net profit after Tax and Interest
Sales

Operating ratio =  Operating ratio shows the

6. Expenses operational efficiency of the
Cost of Goods sold + other
ratios expenses business.
Sales
 Lower operating ratio
shows higher operating profit
and vice versa .

Cost of Goods sold ratio =  It measures the cost of

goods sold per sale.
Cost of Goods
sold
Sales

Specific Expenses ratio =  It measures the specific

expenses per sale.
Speci&ic Expenses
Sales
Sl.No. CATEGORY TYPES OF RATIO INTERPRETATION

7. Return on Return on Assets (ROA) =  It measures the

Investments
Net Pro&it after Taxes ∗ 100 profitability of the total
Total Assets funds per investment of
a firm.
Or
(Net Pro&it after Taxes + Interest) ∗ 100
Total Assets

Or
(Net pro&it after Taxes + Interest) ∗
100
Tangible Assets

Or
(Net Pro&it after Taxes + Interest) ∗ 100
Total Assets

Or
( Net Pro&it after Taxes + Interest) ∗ 100
Fixed Assets

Return on Capital Employed (ROCE) =

(Net Pro&it after Taxes) ∗
100  It measures
profitability of the firm
total capital employed with respect to the total

Or capital employed.
(Net Pro&it after Taxes + Interest) ∗ 100  The higher the ratio,
Total Capital Employed
the more efficient use
Or of capital employed.

(Net Pro&it after Taxes + Interest) ∗ 100

Total Capital Employed − Intangible assets
Sl.No. CATEGORY TYPES OF RATIO INTERPRETATION

Return on Total Shareholders’ Equity =  It reveals how profitably

the owner’s fund has been
Net Pro&it after Taxes ∗ 100 utilized by the firm.
Total shareholder’s equity

Return on Ordinary shareholders equity =  It determines whether the

firm has earned satisfactory
Net profit after taxes less Pref. dividend ∗ 100 return for its equity holders
Ordinary Shareholders Equity or not.

Earnings per Share (EPS) =  It measures the profit

available to the equity
Shareholder’s Net Profit of Equity holders holders on a per share basis.
8. ratios Number of Ordinary Shares

Dividend per Share (DPS) =  It is the net distributed

profit belonging to the
Net pro&its after interest and preference shareholders divided by the
dividend paid to ordinary shareholders number of ordinary shares.
Number of ordinary shares outstanding

Dividend Payout ratio (D/P) =  It shows what percentage

share of the net profit after
Total Dividend To Equityholders taxes and preference
Total net pro&it of dividend is paid to the equity
equityholders
holders.
Or
A high D/P ratio is preferred
Dividend per Ordinary
Share from investor’s point of
Earnings per Share view.

Earnings per Yield =
Earnings per Share
Market Value per Share
Dividend Yield =
Dividend per share
Market Value per share
Price- Earnings ratio (P/E) =
Market value per
Share
Earnings per Share
Earning Power =
Net pro&it after
Taxes
Total Assets
Inventory turnover =
9. Activity Ratios
Sales
Closing Inventory
Raw Material turnover =
Cost of Raw Material used
Average Raw Material
Inventory
Work in Progress turnover =
Cost of Goods manufactured
Average Work in process inventory
Debtors turnover =
Cost of Goods manufactured
Average Work in Process Inventory
 It shows the percentage of
each rupee invested in the
stock that was earned by the
company.
 It shows how much a
company pays out in
dividends each year relative
to its share price.
 It reflects the price
currently paid by the market
For each rupee of
EPS.
 Higher the ratio better it is
for owners.
 It measures the overall
profitability and operational
efficiency of a firm.
 It measures how quickly
inventory is sold.
have
A firm
a high
should
ratio neither
nor a low
ratio.
 It shows how quickly
current assets i.e receivables
or debtors are converted to
cash.
 A firm should neither have
a high ratio nor a low ratio.
Sl. No. CATEGORY TYPES OF RATIO INTERPRETATION

Total Assets turnover =

10. Assets Turnover  It measures the efficiency of a
Ratios Cost of Goods Sold firm in managing and utilizing
Total Assets its assets.

Fixed Assets turnover =  Higher the ratio, more

efficient is the firm in utilizing
Cost of Goods Sold its assets.
Fixed Assets

Capital turnover =

Cost of Goods Sold

Capital Employed

Current Assets turnover =

Cost of Goods Sold

Current Assets