Financial ratios are tools used to analyze and evaluate various aspects of a company's financial performance, health, and efficiency. They help stakeholders (investors, analysts, managers) assess profitability, liquidity, solvency, efficiency, and market performance.
1. Profitability Ratios:
Gross Profit Margin: Measures the profitability of sales after deducting the cost of goods sold (COGS).
Formula: Gross Profit Margin = (Gross Profit / Net Sales) *100
Example: A company with a gross profit of ₹20,000 on net sales of ₹100,000 has a gross profit margin of 20%.
Net Profit Margin: Measures the percentage of revenue that remains as net income after all expenses.
Formula: Net Profit Margin= {Net Income}/{Net Sales}* 100
Example: If a company earns ₹15,000 net income on ₹80,000 net sales, the net profit margin is 18.75%.
2. Liquidity Ratios:
Current Ratio: Indicates a company's ability to meet short-term obligations with short-term assets.
Formula: Current Ratio = {Current Assets}÷{Current Liabilities}
Example: A company with current assets of ₹200,000 and current liabilities of ₹100,000 has a current ratio of 2.0
Quick Ratio (Acid-Test Ratio): Measures the ability to meet short-term obligations using only quick assets (cash, cash equivalents, marketable securities, and accounts receivable).
Formula: Quick Ratio = {Quick Assets} ÷{Current Liabilities}
Example: If quick assets are ₹150,000 and current liabilities are ₹100,000, the quick ratio is 1.5.
3. Solvency Ratios:
Debt-to-Equity Ratio: Measures the proportion of debt and equity used to finance a company's assets.
Formula: {Debt-to-Equity Ratio} = {Total Debt}÷{Shareholders' Equity}
Example: If a company has total debt of ₹400,000 and shareholders' equity of ₹600,000, the debt-to-equity ratio is 0.67.
Interest Coverage Ratio: Indicates a company's ability to cover interest expenses with its operating income.
Formula: {Interest Coverage Ratio} = {Operating Income}/{Interest Expenses}
Example: If operating income is ₹50,000 and interest expenses are ₹10,000, the interest coverage ratio is 5.
4. Efficiency Ratios:
Inventory Turnover Ratio: Measures how many times a company's inventory is sold and replaced over a period.
Formula: {Inventory Turnover Ratio} = {Cost of Goods Sold}/{Average Inventory}
Example: If cost of goods sold is ₹400,000 and average inventory is ₹100,000, the inventory turnover ratio is 4.
Accounts Receivable Turnover Ratio: Measures how quickly a company collects cash from credit sales.
Formula: {Accounts Receivable Turnover Ratio} = {Net Credit Sales}/{Average Accounts Receivable}
Example: If net credit sales are ₹600,000 and average accounts receivable is ₹150,000, the accounts receivable turnover ratio is 4.
5. Market Performance Ratios:
Price-to-Earnings (P/E) Ratio: Measures the valuation of a company's shares relative to its earnings per share (EPS).
Formula: {P/E Ratio} = {Market Price per Share}/{Earnings per Share (EPS)}
Example: If a company's stock price is ₹100 and EPS is ₹10, the P/E ratio is 10.
Dividend Yield: Indicates the percentage return on a company's stock from dividends.
Formula: {Dividend Yield} = {Annual Dividend per Share}/{Market Price per Share} * 100
Example: If annual dividend per share is ₹5 and stock price is ₹100, the dividend yield is 5%.
Conclusion:
Financial ratios provide valuable insights into different aspects of a company's financial performance and position. They are essential tools for investors, analysts, and managers to assess profitability, liquidity, solvency, efficiency, and market valuation. Understanding these ratios and their implications helps stakeholders make informed decisions regarding investments, financial strategies, and business operations.