Financial Ratio Guide

The Most Important Financial Ratios New Investors Need to Know

Before you can begin investing in individual stocks, you need to learn how to calculate financial ratios. Even if you decide to get your financial ratios from your broker or financial site, you still need to know what they represent. Otherwise, you may make a mistake and buy into a company with too much debt, not enough cash to survive, or low profitability. This guide to financial ratios will explain how to calculate the most important financial ratios, and, more importantly, what they mean.

Guide to Financial Statements1

You can't calculate financial ratios without the financial statements! This guide to financial statements provides step-by-step instructions for how to read a balance sheet, income statement, and other important accounting documents.

The 5 Categories of Financial Ratios3

All financial ratios are divided into one of five categories. By learning the five categories, you'll be able to understand what it is you are after when you look at a company's financial statements5 to calculate the ratios.

Price to Cash Flow Ratio6

Some investors prefer to focus on a financial ratio known the price to cash flow ratio instead of the more famous price to earnings ratio (or p/e ratio for short). Sit back, relax, and grab a cup of coffee because you're about to learn everything you ever wanted to know about this often overlooked stock valuation tool.

Price to Earnings Ratio - The P/E Ratio8

The price to earnings ratio, also known as the p/e ratio, is probably the most famous financial ratio in the world. It is used as a quick and dirty way to determine how "cheap" or "expensive" a stock is. The best way to think of it is how much you are willing to pay for every $1 in earnings a company generates. Learn how to calculate it, and much more.

The PEG Ratio10

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The price-to-earnings ratio (or p/e ratio for short) is the most popular way to measure the relative valuation of two stocks. The PEG ratio, however, goes one step further. It stands for the price-toearnings-to-growth ratio. It factors in a company's growth.

Asset Turnover Ratio12

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The asset turnover financial ratio calculates the total sales for each dollar of asset a company owns. It measures a company's efficiency in using its assets.

Current Ratio14
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The current ratio is one of the most famous of all financial ratios. It serves as a test of a company's financial strength and relative efficiency. For instance, you can tell if a company has too much, or too little, cash on hand.

Debt to Equity Ratio16

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The debt to equity ratio is important because investors like to compare the total equity (net worth) of a company to the debt it has. For instance, if you own $100 million worth of hotels and have $30 million in debt, you are going to be less concerned than if you have the same $30 million in debt with only $40 million worth of real estate. Learn how to calculate the debt to equity ratio and why it is important.

Gross Profit Margin18

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The gross profit margin lets you know how much profit is available as a percentage of sales to pay payroll costs, advertising, sales expenses, office bills, etc. It's one of the most important financial ratios you can learn.

Interest Coverage Ratio20

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The interest coverage ratio is an important financial ratio for firms that use a lot of debt. It lets you know how much money is available to cover all of the interest expense a company incurs on the money it owes each year.

Inventory Turnover Ratio1

This financial ratio tells an investor how many times a business turns its inventory over a period of time. It allows you to see if a company has too many of its assets tied up in inventory and is

heading for financial trouble. A really efficient retailer, for instance, is going to have a higher inventory turnover ratio than a less efficient competitor.

Net Profit Margin Ratio3

The net profit margin tells you how much money a company makes for every $1 in revenue. Companies with higher net profit margins can often offer better benefits, heftier bonuses, and fatter dividends.

Operating Profit Margin Ratio5

Operating income, or operating profit as it is sometimes called, is the total pre-tax profit a business generated from its operations. It is what is available to the owners before a few other items need to be paid such as preferred stock dividends and income taxes.

Quick Test Ratio7

The Quick Test Ratio (also called the Acid Test or Liquidity Ratio) is the most excessive and difficult test of a company's financial strength and liquidity.

Receivable Turns9

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The receivable turns or receivable turnover is a great financial ratio to learn when you are analyzing a business or a stock because common sense tells you the faster a company collects its accounts receivables, the better. The sooner customers pay their bills, the sooner a company can put the cash in the bank, pay down debt, or start making new products. There is also a smaller chance of losing money to delinquent accounts. Fortunately, there is a way to calculate the number of days it takes for a business to collect its receivables.

Return on Assets (ROA) Ratio11

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Where asset turnover tells an investor the total sales for each $1 of assets, return on assets, or ROA for short, tells an investor how much profit a company generated for each $1 in assets. The return on assets figure is also a sure-fire way to gauge the asset intensity of a business. It is one of the most important financial ratios you can know.

Return on Equity (ROE) Ratio13

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One of the most important profitability metrics is return on equity (or ROE for short). Return on equity reveals how much profit a company earned in comparison to the total amount of shareholder equity found on the balance sheet.

Advanced Return on Equity: The DuPont Model15

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Once you know how to calculate the return on equity financial ratio, you need to go even further and break it down into the various components. This is called the DuPont analysis. By learning it, you can actually see what it is that makes a company profitable. It is, and remains, the secret to understanding most great fortunes.

Working Capital Per Dollar of Sales17

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The working capital per dollar of sales financial ratio is important because it lets you know how much money a company needs to keep on hand to conduct business. Generally speaking, the more working capital a company needs, the less valuable it is because that's money the owners can't take out of the business in the form of dividends19.