Ratios

Asset Turnover

The amount of sales generated for every dollar's worth of assets. It is calculated by dividing sales in dollars by assets in dollars.

Asset turnover measures the firm's efficiency at using its assets in generating sales or revenue; the higher the number the better. It also indicates pricing strategy: companies with low profit margins tend to have high asset turnover; those with high profit margins have low asset turnover.

Receivables Turnover

An accounting measure used to quantify a firm's effectiveness in extending credit as well as collecting debts. Receivables turnover ratio is an activity ratio, measuring how efficiently a firm uses its assets.

Formula:

Some companies' reports will only show sales - this can affect the ratio depending on the size of cash sales

By maintaining accounts receivable, firms are indirectly extending interest-free loans to their clients. A high ratio implies either that a company operates on a cash basis or that its extension of credit and collection of accounts receivable is efficient.

A low ratio implies the company should re-assess its credit policies in order to ensure the timely collection of imparted credit not earning interest for the firm.

Inventory Turnover

A ratio that shows how many times the inventory of a firm is sold and replaced over a specific period.

Although the first calculation is more frequently used, COGS may be substituted because sales are recorded at market value while inventories are usually recorded at cost. Also, average inventory may be used instead of the ending inventory level to minimize seasonal factors.

This ratio should be compared against industry averages. A low turnover implies poor sales and, therefore, excess inventory. A high ratio implies either strong sales or ineffective buying.

High inventory levels are unhealthy because they represent an investment with a rate of return of zero. It also opens the company up to trouble in the case of falling prices.

Current Ratio

Indicator of company's ability to pay short-term obligations; calculated by dividing current assets by current liabilities.

Current Ratio is useful for comparing companies within the same industry. The higher the ratio, the more liquid the company.

Also known as liquidity ratio, cash asset ratio, and cash ratio.

Quick Ratio

An indicator of a company's financial strength. It is calculated as:

Basically, it is a measure of how quickly a company's assets can be turned in cash.

debt ratio

A ratio that indicates what proportion of debt a company has relative to its assets. It is calculated by dividing total debts by total assets.

A debt ratio greater than 1 indicates that a company has more debt than assets, and a debt ratio less than 1 indicates a company has more assets than debt. Used in conjunction with other measures of financial health, the debt ratio can help investors determine a company's level of risk.

Debt to Equity Ratio

A measure of a company's financial leverage calculated by dividing long-term debt by stockholder equity. It indicates what proportion of equity and debt the company is using to finance its assets.

Note: Sometimes only interest-bearing long-term debt is used instead of total liabilities in the calculation.

A high debt/equity ratio generally means a company has been aggressive in financing its growth with debt. This can result in volatile earnings as a result of the additional interest expense.

If a lot of debt is used to finance increased operations (high debt to equity), the company could potentially generate more earnings than it would have without this outside financing. If this were to increase earnings by a greater amount than the debt cost (interest) then the shareholders benefit as more earnings are being spread around to the same amount of shareholders. However, the cost of this debt financing may outweigh the return that the company generates on the debt through investment and business activities and become too much for the company to handle, which may result in bankruptcy and leave shareholders with nothing, so it is a delicate balance. This is what the leverage effect is about and what the debt/equity ratio measures.

The debt/equity ratio will also be dependent on the industry the company operates in. For example, capital-intensive industries such as auto manufacturing tend to have a debt-to-equity ratio above 2, while personal computer companies have a debt to equity of under 0.5.

Gross Profit Margin

1) A company's total sales revenue minus its cost of goods sold.

2) A company's total sales revenue minus cost of goods sold, divided

by the total sales revenue, expressed as a percentage.

3) In the case of an adjustable-rate mortgage, the interest rate (expressed as a percentage) that is added on to the base index rate in order to establish the actual interest rate the borrower will pay on the loan.

1) This dollar amount represents the amount of money the company generated over the cost of producing its goods or services. This amount can then be used to pay fixed expenses such as leasehold