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Financial Ratios
Every company needs to measure its performance objectively. Please find a list below of some of the common financial ratios and metrics we use with our clients. We compare our clients’ numbers to their respective industry averages as well as overall business criteria.
LIQUIDITY RATIOS
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WORKING CAPITAL
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Total Current Assets – Total Current Liabilities
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Explanation: This metric is a measure of both a company’s efficiency and its short-term financial health. Positive working capital means that the company is able to pay off its short-term liabilities. Negative working capital means that a company currently is unable to meet its short-term liabilities with its current assets.
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CURRENT RATIO
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Total Current Assets / Total Current Liabilities
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Explanation: Generally, this metric measures the overall liquidity position of a company. It is certainly not a perfect barometer, but it is a good one. Watch for big decreases in this number over time. Make sure the accounts listed in “current assets” are collectible.
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QUICK RATIO
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(Cash + Accounts Receivable) / Total Current Liabilities
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Explanation: This is another good indicator of liquidity, although by itself, it is not a perfect one. If there are receivable accounts included in the numerator, they should be collectible. Look at the length of time the company has to pay the amount listed in the denominator (current liabilities).
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INVENTORY DAYS
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(Inventory / COGS) * 365
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Explanation: This metric shows how much inventory (in days) is on hand. It indicates how quickly a company can respond to market and/or product changes. Not all companies have inventory for this metric.
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ACCOUNTS RECEIVABLE DAYS
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(Accounts Receivable / Sales) * 365
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Explanation: This metric shows how much inventory (in days) is on hand. It indicates how quickly a company can respond to market and/or product changes. Not all companies have inventory for this metric.
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ACCOUNTS PAYABLE DAYS
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(Accounts Payable / COGS) * 365
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Explanation: This ratio shows the average number of days that lapse between the purchase of material and labor, and payment for them. It is a rough measure of how timely a company is in meeting payment obligations.
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PROFITS AND PROFIT MARGINS
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GROSS PROFIT MARGIN
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(Sales – COGS) / Sales
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Explanation: The financialmetric 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. Gross profit margin serves as the source for paying additional expenses and future savings.
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NET PROFIT MARGIN
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Adjusted Net Profit before Taxes / Sales
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Explanation: This is an important metric. In fact, over time, it is one of the more important barometers that we look at. It measures how many cents of profit the company is generating for every dollar it sells. Track it carefully against industry competitors. This is a very important number in preparing forecasts.
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ADVERTISING TO SALES
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Advertising Expense / Sales
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Explanation: This metric shows advertising expense for the company as a percentage of sales.
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RENT TO SALES
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RentExpense / Sales
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Explanation: This metric shows rent expense for the company as a percentage of sales.
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PAYROLL TO SALES
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PayrollExpense / Sales
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Explanation: This metric shows payroll expense for the company as a percentage of sales.
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BORROWING RATIOS
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EBITDA
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Revenue – Expenses (excluding interest, tax depreciation, and amortization)
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Explanation: Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) can be used to analyze and compare profitability between companies and industries because it eliminates the effects of financing and accounting decisions.
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INTEREST COVERAGE RATIO
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EBITDA / Interest Expense
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Explanation: This ratio measures a company’s ability to service debt payments from operating cash flow (EBITDA). An increasing ratio is a good indicator of improving credit quality.
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DEBT-TO-EQUITY RATIO
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Total Liabilities / Total Equity
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Explanation: This Balance Sheet leverage ratio indicates the composition of a company’s total capitalization — the balance between money or assets owed versus the money or assets owned. Generally, creditors prefer a lower ratio to decrease financial risk while investors prefer a higher ratio to realize the return benefits of financial leverage.
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DEBT LEVERAGE RATIO
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Total Liabilities / EBITDA
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Explanation: This ratio measures a company’s ability to repay debt obligations from annualized operating cash flow (EBITDA).
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ASSETS RATIOS
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RETURN ON EQUITY
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Net Income / Total Equity
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Explanation: This measure shows how much profit is being returned on the shareholders’ equity each year. It is a vital statistic from the perspective of equity holders in a company.
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RETURN ON ASSETS
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Net Income / Total Assets
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Explanation: This calculation measures the company’s ability to use its assets to create profits. Basically, ROA indicates how many cents of profit each dollar of asset is producing per year. It is quite important since managers can only be evaluated by looking at how they use the assets available to them.
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FIXED ASSET TURNOVER
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Sales / Gross Fixed Assets
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Explanation: This asset management ratio shows the multiple of annualized sales that each dollar of gross fixed assets is producing. This indicator measures how well fixed assets are “throwing off” sales and is very important to businesses that require significant investments in such assets. Readers should not emphasize this metric when looking at companies that do not possess or require significant gross fixed assets.
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