Fundamenetal Financial Ratios

FINANCIAL RATIOS ARE THE KEY in Understanding the Company’s Financial Health.

Learning these formula by heart will allow you to excel in your management of company’s finance.

There are three ways in which financial ratios are used by management as part of the financial planning and control process. These three methods are:

  1. Comparison of Company’s Present Ratio with Industry Averages
  2. Comparison of Company’s Present Ratio with its Historical Ratios
  3. Comparison of the Company’s Forecasted (Pro-Forma) ratios with the company’s actual ratios

The ratios given below are the most popular ratios used by Financial Analyst. It is important to keep note of these if you are looking for work at a financial industry since they are the standard knowledge.

NOTE: Some ratios are calculated using the average of the beginning and ending balance of an item. For example, in calculating total asset turnover, the ratio may be calculated as Sales ÷ ((Beginning assets + Ending Assets)/2). In other instances, ratios may be calculated using end-of-period balances as Sales/Ending assets. The below ratios will mostly use the “end-of-period” balance, with exception of profit ratio calculation.

  1. Liquidity Ratios – Measures the company’s ability to meet its maturing short-term obligations (money borrowed)A. Current Ratio = Current Assets/Current Liabilities
    B. Quick Ratio = (Current Assets – Ending Inventory)  ÷ Current Liabilities
  2. Activity Ratios – Measures how effectively the company is using its resources.A. Inventory Turnover =  Cost of Goods Sold ÷ Ending Inventory
    B. Days of Inventory = Ending Inventory ÷ (Cost of Goods Sold÷365)

    NOTE: COGS ÷ 365 = Days of Inventory.
    In other word, if you run a company and have different raw materials required to make the product. Those raw materials would be the inventory. And if the days of inventory are short, then your company is effectively utilize the inventory without creating any loss from holding inventory. You used every raw materials you needed to sell your products at your customers’ demand.

    C. Days of Sales (DSO) = Ending Account Receivables ÷ (Credit Sales ÷ 365 Days)
    D. Days of Purchasing Outstanding (DPO) = Ending Accounts Payable ÷ (Purchases ÷ 365 Days)

    E. Asset Turnover =  Sales ÷ Ending Assets