Financial Ratios Glossary
Cash Flow-Solvency Ratios
Accounts Payable
Business Revenue: Accounts Payable/Annual Business Revenue, measuring the speed with which a company pays vendors relative to Business Revenue. Numbers higher than typical industry ratios suggest that the company may be using suppliers to float operations.
Current Ratio
This is the same as Current Assets/Current Liabilities, measuring current assets available to cover current liabilities, a test of near-term solvency. The ratio indicates to what extent cash on hand and disposable assets are enough to pay off near term liabilities. The Quick Ratio is applied as a more stringent test.
Quick Ratio
(Cash plus Accounts Receivable)/Current Liabilities, indicating liquid assets available to cover current debt. Also known as the Acid Ratio. This is a harsher version of the Current Ratio, which balances short-term liabilities against cash and liquid instruments.
Days Payables
365/(Cost of Sales: Accounts Payable ratio): Reflects the average number of days for each payable before payment is made.
Current Liabilities
Inventory: Current Liabilities/Inventory: A high ratio, relative to industry norms, suggests over-reliance on unsold goods to finance operations.
Net Working Capital
(Current Assets-Current Liabilities)/Business Revenue: Indicates if a company is maintaining a reasonable level of liquidity relative to its Business Revenue volume. Higher is generally better, but very high ratios may indicate an overly conservative reliance on liquid assets, while low ratios suggest the opposite. Your score suggests that the business may reflect weakness in liquidity practices.
Cost of Sales: Accounts Payable
Measures the number of times payables turn over in the course of the year. High measures may indicate cash flow concerns.
Cost of Sales: Inventory
Reflects the number of times inventory is turned over during the course of the year. High levels can mean good liquidity or Business Revenue, or shortages requiring better management. Low levels may indicate poor cash flow or overstocking.
Profitability Ratios
EBITDA: Business Revenue
Earnings Before Interest, (income) Taxes due, Depreciation and Amortization/Business Revenue. EBITDA: Business Revenue is a relatively controversial (and often criticized) metric designed to eliminate the effect of finance and accounting decisions when comparing companies and industry benchmarks. Tax credits and deferral procedures and non-cash expenditures (Amortization and Depreciation) are not deducted from the profit equation, as are interest expenditures.
Return on Assets
Pre-Tax or After Tax Net Profit/Total Assets, a critical indicator of profitability. Companies which use their assets efficiently will tend to show a ratio higher than the industry norm. The ratio may appear higher for small businesses due to owner compensation draws accounted as net profit.
Return on Net Worth
Pre-Tax or After Tax Net Profit/Net Worth. This is the 'final measure' of profitability to evaluate overall return. This ratio measures return relative to investment, how well a company leverages the investment in it. May appear higher for small businesses due to owner compensation draws accounted as net profit.
Return on Business Revenue
Pre-Tax or After Tax Net Profit Net Profit/Annual Business Revenue, indicating the level of profit from each dollar of Business Revenue. This ratio can be used as a predictor of the company's ability to withstand changes in prices or market conditions. May appear higher for small businesses due to owner compensation draws accounted as net profit.
Discretionary Owner Earnings
Sums Officer Compensation, Depreciation and related non cash expenses and Net Profit after business taxes to represent a practical measure of total return to owners. The D.O.E. metric is mainly used for small businesses.
Profit/Employee
Pre-Tax Net Profit/Full-time Employees.
Owner Earnings/Employee
Discretionary Owner Earnings (Officers' Compensation+Depreciation+After Tax Net Profit)/Full-time Employees.
Efficiency Ratios
Assets
Business Revenue: Total Assets/Business Revenue, indicating whether a company is handling too high a volume of Business Revenue in relation to investment. Very low percentages relative to industry norms might indicate overly conservative sales efforts or poor sales management.
Days Inventory
365/(Cost of Sales: Inventory): The average number of days of items in inventory.
Days Receivables
365/(Business Revenue/Receivables): Reflects the number of days that receivables are outstanding. Target average or lower.
Current Asset Turnover
Business Revenue/Current Assets. A general indicator of the efficiency of asset use. Target at or slightly below industry level.
Fixed Asset Turnover
Business Revenue/Fixed Assets. An indicator of the efficiency of investment in fixed asset such as plant and equipment. Target at or slightly below industry level
Gross Margin
Business Revenue: Pre-tax Gross Profit/Annual Business Revenue. This is the profit ratio before product and Business Revenue costs, as well as taxes. This ratio can indicate the "play" in other expenses which could be adjusted to increase the Net Profit margin.
Sales per Employee
Business Revenue/FTE Employees: A basic efficiency measure developed outside the formal financial statement, often reflecting relative value-added. Higher is usually better.
Inventory Turnover
Business Revenue/Inventory. This ratio gives a picture of how quickly inventory turns over. Ratios below the industry norm suggest high levels of inventory. High ratios could indicate product levels insufficient to satisfy demand in a timely manner. Target: at or slightly above industry level.
Receivables Turnover
Business Revenue/Receivables. An indicator of how efficiently invoiced sales are collected. Target at or slightly above industry level.
Total Asset Turnover
Business Revenue/Total Assets. Target: at or slightly below industry level.
Working Capital Turnover
Business Revenue divided by Net Working Capital (current assets minus current liabilities). Ratios higher than industry norms may indicate a strain on available liquid assets, while low ratios may suggest too much liquidity. Target: at or above industry level.
Days Working Capital
365/ (Working Capital Turnover): Expresses the coverage in number of days of available working capital.
Cash Turnover
Business Revenue/Cash. Indicates efficiency in the use of cash to develop Business Revenue. A more stringent ratio than Working Capital Turnover (below). Target at or slightly below industry level.
Efficiency Index
Sales per Employee/Average Annual Employee Wage.
Debt-Risk Ratios
Interest Coverage
EBITDA/Interest Expense: Earnings before Interest, (income) Taxes due, Depreciation and Amortization divided by Interest expense. Assesses financial stability by examining whether a company is at least profitable enough to pay interest expense. A ratio >1.00 indicates it is. See cautions in the listing for EBITDA.
Current Liabilities
Net Worth: Total Current Liabilities/Net Worth, a measure of short-term debt coverage (>1 year). This ratio reflects a level of security for creditors. The larger the ratio relative to industry norms, the less security there is for creditors.
Long-Term Liabilities
Net Worth: Long-Term Liabilities/Net Worth, a measure of coverage of long-term debt (>1 year).
Loans/Notes Payable
Net Worth: The Loans/Notes Payable portion of current liabilities divided by Net Worth, a measure of debt coverage.
Modified Z-Score
A modified form of the Altman Z-Score which evaluates default risk. The modified Z-Score substitutes Discretionary Owner Earnings for Net Profit and Net Worth for Retained Earnings to better capture small business operations. In all cases higher (at or above the industry level) is desired. Modified Z-Score calculations for this industry are:
For manufacturing industries
([Working Capital/Total Assets]*0.717) + ([Discretionary Owner Earnings/Total Assets]*0.847) + ([Operating Income/Total Assets]*3.107) + ([Net Worth/Total Liabilities]*0.420) + ([Sales/Total Assets]*.998)
For all non-manufacturing industries
([Operating Income/Total Assets]*6.72) + ([Net Worth/Total Liabilities]*1.05) + ([Working Capital/Total Assets]*6.5) + ([Discretionary Owner Earnings/Total Assets]*3.26)
Total Liabilities
Net Worth: Total Liabilities/Net Worth, a measure of coverage of total debt (short and long-term). Creditors are concerned to the extent that total liability levels exceed Net Worth.
Fixed Assets
Net Worth: Fixed Assets/Net Worth. High ratios relative to the industry can indicate low working capital or high levels of debt.
