Financial ratios are powerful analytical tools used by accountants, managers, and investors to understand a company’s performance from all angles—liquidity, solvency, profitability, efficiency, and valuation.
This in-depth guide expands the 10 Financial Ratio Cheat sheet with detailed explanations, interpretation guidance, sample calculations, and Excel-friendly templates.
Financial Ratios
Liquidity Ratios
Liquidity ratios show a company’s ability to meet short-term obligations. They’re crucial for evaluating working capital health.
Current Ratio
Formula:
Current Assets ÷ Current Liabilities
Interpretation
- > 2.0 = strong liquidity
- 1.0–2.0 = acceptable
- < 1.0 = liquidity risk
Real-World Example
Suppose a retail company has:
- Current Assets = $450,000
- Current Liabilities = $300,000
Current Ratio = 450,000 ÷ 300,000 = 1.5
This means:
The company has $1.50 in liquid assets for every $1 of short-term liability.
| Description | Value |
|---|---|
| Current Assets | 450000 |
| Current Liabilities | 300000 |
| Current Ratio | =B2/B3 |
Quick Ratio (Acid-Test Ratio)
Formula:
(Current Assets – Inventory) ÷ Current Liabilities
Interpretation
Shows immediate liquidity without relying on inventory.
Example
- Current Assets = $450,000
- Inventory = $120,000
- Current Liabilities = $300,000
Quick Ratio = (450,000 – 120,000) ÷ 300,000
= 330,000 ÷ 300,000
= 1.10
| Description | Value |
|---|---|
| Current Assets | 450000 |
| Inventory | 120000 |
| Current Liabilities | 300000 |
| Quick Ratio | =(B2-B3)/B4 |
Solvency Ratios
Solvency ratios reflect long-term financial stability and debt-servicing capacity.
Debt-to-Equity Ratio (D/E)
Formula:
Total Debt ÷ Total Equity
Interpretation
- High D/E = aggressive debt financing
- Low D/E = conservative financing and lower risk
Example
- Total Debt = $800,000
- Equity = $600,000
D/E = 800,000 ÷ 600,000 = 1.33
This means the company uses $1.33 of debt for every $1 of equity.
| Description | Value |
|---|---|
| Total Debt | 800000 |
| Total Equity | 600000 |
| D/E Ratio | =B2/B3 |
Interest Coverage Ratio
Formula:
EBIT ÷ Interest Expense
Interpretation
Measures ability to pay interest using operational income.
- > 3 = strong
- 1.0–2.0 = risky
- < 1.0 = cannot cover interest
Example
- EBIT = $250,000
- Interest Expense = $80,000
Interest Coverage = 250,000 ÷ 80,000 = 3.125
| Description | Value |
|---|---|
| EBIT | 250000 |
| Interest Expense | 80000 |
| Interest Coverage | =B2/B3 |
Profitability Ratios
Net Profit Margin
Formula:
Net Profit ÷ Revenue × 100
Interpretation
Shows profit generated from every dollar of sales.
Example
- Revenue = $1,000,000
- Net Profit = $150,000
Net Profit Margin = (150,000 ÷ 1,000,000) × 100 = 15%
| Description | Value |
|---|---|
| Net Profit | 150000 |
| Revenue | 1000000 |
| Net Profit Margin | =(B2/B3)*100 |
Return on Assets (ROA)
Formula:
Net Profit ÷ Average Assets × 100
Interpretation
Measures efficiency of total asset utilization.
Example
- Net Profit = $150,000
- Beginning Assets = $1,200,000
- Ending Assets = $1,000,000
Average Assets = (1,200,000 + 1,000,000) ÷ 2
= 1,100,000
ROA = (150,000 ÷ 1,100,000) × 100 = 13.64%
| Description | Value |
|---|---|
| Net Profit | 150000 |
| Beginning Assets | 1200000 |
| Ending Assets | 1000000 |
| Average Assets | =(B3+B4)/2 |
| ROA | =(B2/B5)*100 |
Return on Equity (ROE)
Formula:
Net Profit ÷ Equity × 100
Example
- Net Profit = $150,000
- Equity = $600,000
ROE = (150,000 ÷ 600,000) × 100 = 25%
High ROE indicates strong shareholder returns.
| Description | Value |
|---|---|
| Net Profit | 150000 |
| Equity | 600000 |
| ROE | =(B2/B3)*100 |
Efficiency Ratios
Inventory Turnover
Formula:
COGS ÷ Average Inventory
Interpretation
Shows how frequently inventory is sold and replenished.
Example
- COGS = $900,000
- Opening Inventory = $150,000
- Closing Inventory = $170,000
Average Inventory = (150,000 + 170,000) ÷ 2
= 160,000
Inventory Turnover = 900,000 ÷ 160,000 = 5.63 times
| Description | Value |
|---|---|
| COGS | 900000 |
| Opening Inventory | 150000 |
| Closing Inventory | 170000 |
| Average Inventory | =(B3+B4)/2 |
| Inventory Turnover | =B2/B5 |
Asset Turnover Ratio
Formula:
Net Sales ÷ Average Assets
Example
- Net Sales = $1,000,000
- Average Assets = $1,100,000
Asset Turnover = 1,000,000 ÷ 1,100,000 = 0.91
| Description | Value |
|---|---|
| Net Sales | 1000000 |
| Average Assets | 1100000 |
| Asset Turnover | =B2/B3 |
Valuation Ratio
Price-to-Earnings (P/E) Ratio
Formula:
Market Price per Share ÷ Earnings per Share (EPS)
Example
- Market Price = $50 per share
- EPS = $2.50
P/E = 50 ÷ 2.50 = 20
| Description | Value |
|---|---|
| Market Price | 50 |
| EPS | 2.5 |
| P/E Ratio | =B2/B3 |
Complete Financial Ratio Summary Table
You can copy/paste this table directly into Excel:
| Ratio | Formula (Excel) | Example Result |
|---|---|---|
| Current Ratio | =CurrentAssets/CurrentLiabilities | 1.50 |
| Quick Ratio | =(CurrentAssets-Inventory)/CurrentLiabilities | 1.10 |
| Debt-to-Equity | =TotalDebt/Equity | 1.33 |
| Interest Coverage | =EBIT/InterestExpense | 3.13 |
| Net Profit Margin | =(NetProfit/Revenue)*100 | 15% |
| ROA | =(NetProfit/AverageAssets)*100 | 13.64% |
| ROE | =(NetProfit/Equity)*100 | 25% |
| Inventory Turnover | =COGS/AverageInventory | 5.63 |
| Asset Turnover | =NetSales/AverageAssets | 0.91 |
| P/E Ratio | =MarketPrice/EPS | 20 |
Liquidity: Can the Company Pay Its Bills?
Liquidity ratios measure a company’s ability to meet its short-term debt obligations. They are a snapshot of immediate financial health.
| Ratio | Formula | Key Insight |
| Current Ratio | Current Assets $\div$ Current Liabilities | Short-term financial health. A ratio above 1 is generally desirable. |
| Quick Ratio | (Current Assets – Inventory) $\div$ Current Liabilities | Immediate liquidity (without stock). Measures the ability to pay debts using only the most liquid assets. |
Solvency: How is the Company Leveraged?
Solvency ratios assess a company’s ability to meet its long-term debt obligations. They focus on the capital structure and overall risk.
| Ratio | Formula | Key Insight |
| Debt-to-Equity Ratio | Total Debt $\div$ Equity | Leverage & risk profile. Shows how much debt a company is using to finance its assets relative to shareholder funds. |
| Interest Coverage Ratio | EBIT $\div$ Interest Expense | Ability to service debt interest. Indicates how easily a company can pay the interest on its outstanding debt. |
Profitability: How Effective is the Business at Generating Income?
These ratios are perhaps the most closely watched, as they reveal how effectively a company is using its resources to generate profit.
| Ratio | Formula | Key Insight |
| Net Profit Margin | Net Profit $\div$ Revenue $\times 100$ | Profitability of sales. What percentage of every dollar of sales translates into profit. |
| Return on Assets (ROA) | Net Profit $\div$ Avg. Assets $\times 100$ | Efficiency in using assets. How well a company uses its assets to generate earnings. |
| Return on Equity (ROE) | Net Profit $\div$ Equity $\times 100$ | Return for shareholders. Measures the return generated on the shareholders’ investment. |
Efficiency: How Well is the Business Operating?
Efficiency ratios focus on how well a company manages its operational assets and liabilities, like inventory and fixed assets.
| Ratio | Formula | Key Insight |
| Inventory Turnover | COGS $\div$ Avg. Inventory | Speed of selling inventory. How many times a company has sold and replaced inventory during a period. |
| Asset Turnover Ratio | Net Sales $\div$ Avg. Assets | Revenue generation efficiency. How much revenue is generated for every dollar of assets. |
Valuation: What Does the Market Think?
Valuation ratios bridge financial performance with market expectation, helping investors determine if a stock is fairly priced.
| Ratio | Formula | Key Insight |
| Price-to-Earnings (P/E) | Market Price $\div$ EPS | Market expectation of growth. The amount an investor is willing to pay for every dollar of a company’s earnings. |
Profitability Ratios: A Case Study
Imagine a company, “Tech Innovations Inc.,” reports the following results for the year:
| Metric | Value |
| Net Profit | $100,000 |
| Revenue (Net Sales) | $500,000 |
| Total Equity | $200,000 |
| Average Total Assets | $400,000 |
That’s great! Let’s dive into Profitability with a real-world example, as it is often the most important area for stakeholders.
💰 Profitability Ratios: A Case Study
Imagine a company, “Tech Innovations Inc.,” reports the following results for the year:
| Metric | Value |
| Net Profit | $100,000 |
| Revenue (Net Sales) | $500,000 |
| Total Equity | $200,000 |
| Average Total Assets | $400,000 |
Here is how we calculate their three key profitability ratios using the formulas from the cheatsheet:
1. Net Profit Margin
This ratio shows the percentage of revenue remaining after all operating expenses, interest, taxes, and preferred stock dividends have been deducted.
- Formula: Net Profit $\div$ Revenue $\times 100$
- Calculation: $(\$100,000 \div \$500,000) \times 100 = 20\%$
- Insight: For every dollar in revenue, Tech Innovations Inc. keeps 20 cents as profit.
2. Return on Assets (ROA)
ROA measures how efficiently the company uses its total assets (both financed by debt and equity) to generate profit.
- Formula: Net Profit $\div$ Avg. Assets $\times 100$
- Calculation: $(\$100,000 \div \$400,000) \times 100 = 25\%$
- Insight: Tech Innovations Inc. generates 25 cents of profit for every dollar in assets it owns.
3. Return on Equity (ROE)
ROE is a critical measure for shareholders, showing the return generated on their specific investment (equity).
- Formula: Net Profit $\div$ Equity $\times 100$
- Calculation: $(\$100,000 \div \$200,000) \times 100 = 50\%$
- Insight: For every dollar of shareholder equity invested, the company generates 50 cents in profit.
The 50% ROE is significantly higher than the 25% ROA. This suggests that Tech Innovations Inc. is likely using a good amount of debt (leverage) to finance its assets, which magnifies the return to its shareholders.
Conclusion
These ratios—when understood deeply—become a powerful toolkit for analyzing any company’s health. They help you judge profitability, predict risk, evaluate efficiency, and make smarter investment or business decisions.
FAQs
Why are these ratios grouped into different categories?
Financial ratios are grouped into categories like Liquidity, Solvency, Profitability, Efficiency, and Valuation because each group addresses a different fundamental question about the business. For example, Liquidity answers, “Can the company pay its immediate bills?” while Solvency answers, “Can the company meet its long-term debt obligations?” Grouping them helps analysts conduct a holistic review of the company’s financial health, ensuring no critical area is overlooked.
What is considered a “good” Current Ratio or Quick Ratio?
Generally, a Current Ratio of 2:1 (Current Assets are twice Current Liabilities) is considered healthy, meaning the company has a strong buffer to cover short-term debts. For the Quick Ratio (which excludes inventory), 1:1 is often seen as acceptable. However, what is considered “good” varies significantly by industry. A grocery store might have a low Current Ratio because its inventory moves fast, while a manufacturing company might require a much higher ratio.
What is the key difference between ROA and ROE?
Return on Assets (ROA) measures the efficiency of the entire business (all assets, regardless of how they were financed) in generating profits. It shows the true operating performance.
Return on Equity (ROE) measures the return specifically generated on the shareholders’ investment. The difference between ROA and ROE is largely explained by leverage (debt). If ROE is significantly higher than ROA, it means the company is successfully using debt to magnify the returns to its shareholders.
How does the P/E Ratio (Valuation) relate to the other ratios?
The Price-to-Earnings (P/E) Ratio connects a company’s financial performance (its Earnings Per Share, or EPS) to the stock market’s view of the company. A high P/E ratio suggests that the market expects high future growth (hence the “Market expectation of growth” insight). Investors are willing to pay more for each dollar of current earnings because they anticipate those earnings will rapidly increase, linking directly to future Profitability and Efficiency expectations.
If a company has a low Net Profit Margin, what other ratio should I check immediately?
If the Net Profit Margin is low, you should immediately check the Efficiency ratios, specifically the Asset Turnover Ratio (Net Sales $\div$ Avg. Assets).
A business with a low profit margin can still be profitable overall if it has a high asset turnover (sells a high volume quickly, like a discount retailer).
Conversely, a business with a high profit margin (like a luxury brand) can succeed with a low asset turnover.
This complementary analysis helps identify the company’s core business model.
