Calculating Financial Ratios (ratios attached)

Page 1 of 1 Financial Management

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Financial Ratios

Market value ratios: An important market value ratio is the price-earnings (PE) ratio. Typically, value investors seek to locate companies with PE ratios below the market PE ratio; they would characterize such companies as undervalued.

Profitability ratios: Profitability ratios measure how effectively a firm is able to generate earnings. An important profitability ratio is the return on equity ratio. It is measured by dividing a firm’s net income by its total equity and is expressed in percentage. The higher the number, the better it is.

Turnover ratios: An important turnover ratio is the inventory turnover ratio; the higher this number, the more effectively a firm is able to utilize its inventory. Turnover ratios help to measure how effectively assets are being utilized to produce revenues.

Leverage ratios: An important leverage ratio is the debt/equity ratio; this ratio will vary by industry. Computer software firms tend to have relatively low debt/equity ratios, whereas utility firms tend to have relatively high debt/equity ratios. Leverage ratios tell how effectively a firm is able to pay its long-term debts.

Liquidity ratios: An important liquidity ratio is the current ratio; this is calculated by dividing a firm’s current assets by its current liabilities. It is good if this ratio is a little greater than 2.0. Liquidity ratios help to tell if a firm is able to pay off its short-term debts.