Financial Ratios Cheat Sheet: Key Formulas and How to Use Them

Whether reviewing a company’s financial health or comparing investment opportunities, financial ratios offer insights that raw numbers alone cannot provide. They distill complex financial statements into simpler metrics, aiding investors, analysts, and business owners in making more informed decisions.

This guide outlines common financial ratio formulas and explains their application.

Essential Ratio Categories

Financial ratios are typically grouped into categories, each offering a different perspective on a company’s financial standing and operational effectiveness.

Profitability Ratios

Profitability ratios gauge a company’s ability to generate earnings relative to its revenue, costs, assets, or equity. These metrics show how effectively a company converts sales into profit and uses resources to create shareholder value. Examples include gross profit margin, net profit margin, Return on Assets (ROA), and Return on Equity (ROE). Analyzing these helps assess financial health and efficiency, often through comparison against past performance or industry peers.

Liquidity Ratios

Liquidity ratios evaluate a company’s capacity to meet its short-term financial obligations, typically those due within one year. They assess whether sufficient liquid assets—like cash, marketable securities, and accounts receivable—are available to cover these immediate debts. Key examples are the Current Ratio and the Quick Ratio (or Acid-Test Ratio). Higher liquidity ratios generally suggest a better position to handle short-term debts without needing external funds or selling long-term assets quickly.

Efficiency Ratios

Efficiency ratios, also known as activity or turnover ratios, assess how effectively a company uses its assets and manages liabilities to generate revenue. These ratios offer insights into operational performance. For instance, the Inventory Turnover Ratio measures the speed at which inventory is sold, while the Asset Turnover Ratio indicates how efficiently total assets generate sales. Analyzing these helps understand the management of the operational cycle.

Leverage Ratios

Leverage ratios, sometimes called solvency ratios, measure the extent to which a company uses debt to finance its assets. They provide insight into capital structure and the ability to meet long-term obligations, helping assess financial risk. Common examples include the Debt-to-Equity Ratio and the Debt-to-Assets Ratio. The Interest Coverage Ratio evaluates the ability to pay interest expenses. While debt can amplify returns, high leverage increases financial risk if profitability declines.

Valuation Ratios

Valuation ratios help investors assess an investment’s attractiveness by comparing a stock’s price to financial metrics like earnings or book value. These ratios help determine if a stock seems overvalued, undervalued, or fairly priced. Widely used examples include the Price-to-Earnings (P/E) Ratio, the Price-to-Book (P/B) Ratio, and the Price-to-Sales (P/S) Ratio. These are fundamental tools for investment analysis.

Key Financial Data Points

Calculating financial ratios requires specific data points primarily sourced from a company’s core financial statements: the balance sheet, income statement, and cash flow statement. Publicly traded companies in the U.S. file these statements with the Securities and Exchange Commission (SEC), making them accessible via the EDGAR database. Annual (Form 10-K) and quarterly (Form 10-Q) reports contain these statements, prepared according to Generally Accepted Accounting Principles (GAAP).

The balance sheet presents a company’s financial position at a specific moment. Key data includes assets (like cash, accounts receivable, inventory), liabilities (such as accounts payable, short-term debt), and shareholders’ equity. These elements reflect what a company owns, owes, and the owners’ net worth, adhering to the accounting equation: Assets = Liabilities + Equity.

The income statement reports financial performance over a period, like a quarter or year. Important figures include revenue, cost of goods sold (COGS), gross profit, operating expenses, operating income (EBIT), interest expense, and net income. These items show how revenue becomes profit after accounting for costs.

The statement of cash flows tracks cash movements over the period, categorized into operating, investing, and financing activities. While less commonly used for basic ratios, data like cash flow from operations or capital expenditures can be inputs for specific analyses, offering a view of actual cash generation and use.

Consistency is needed when extracting data. When comparing an income statement item (period-based) with a balance sheet item (point-in-time), using an average balance sheet figure (e.g., (beginning balance + ending balance) / 2) can be more representative. The notes accompanying financial statements provide further detail on accounting policies and figures, aiding understanding.

Common Ratio Formulas

Understanding the calculation of common financial ratios is fundamental.

The Current Ratio measures the ability to cover short-term obligations using short-term assets.
Current Ratio = Current Assets / Current Liabilities

The Quick Ratio offers a stricter liquidity test by excluding inventory from current assets.
Quick Ratio = (Current Assets – Inventory) / Current Liabilities

The Gross Profit Margin shows the percentage of revenue remaining after accounting for the cost of goods sold.
Gross Profit Margin = Gross Profit / Revenue

The Net Profit Margin indicates the percentage of revenue left as profit after all expenses are deducted.
Net Profit Margin = Net Income / Total Revenue

Return on Assets (ROA) measures profitability relative to total assets, showing efficiency in asset use. Average total assets are often used in the denominator.
Return on Assets (ROA) = Net Income / Average Total Assets

Return on Equity (ROE) measures the return generated on shareholders’ investments. Average shareholders’ equity is typically used.
Return on Equity (ROE) = Net Income / Average Shareholders’ Equity

The Inventory Turnover Ratio measures how many times inventory is sold and replaced over a period. Average inventory is commonly used.
Inventory Turnover Ratio = Cost of Goods Sold / Average Inventory

The Asset Turnover Ratio measures how efficiently assets generate sales. Average total assets are often used.
Asset Turnover Ratio = Net Sales / Average Total Assets

The Debt-to-Assets Ratio measures the proportion of assets financed through debt.
Debt-to-Assets Ratio = Total Debt / Total Assets

The Debt-to-Equity Ratio compares total debt to shareholders’ equity, indicating financial leverage.
Debt-to-Equity Ratio = Total Debt / Total Shareholders’ Equity

The Interest Coverage Ratio assesses the ability to pay interest expenses using operating earnings.
Interest Coverage Ratio = EBIT / Interest Expense

The Price-to-Earnings (P/E) Ratio compares the stock price to earnings per share (EPS).
Price-to-Earnings (P/E) Ratio = Market Price per Share / Earnings Per Share (EPS)

The Price-to-Book (P/B) Ratio compares a stock’s market value to its book value per share.
Price-to-Book (P/B) Ratio = Market Price per Share / Book Value per Share

The Price-to-Sales (P/S) Ratio compares the stock price to revenue per share.
Price-to-Sales (P/S) Ratio = Market Price per Share / Sales per Share

Basic Ratio Interpretation

Interpreting financial ratios requires context. A single ratio value offers limited insight; comparison is necessary. Evaluating a ratio against industry benchmarks, competitors, or the company’s historical performance provides a more meaningful understanding.

For liquidity ratios like the current ratio, a value above 1.0 generally suggests a company can cover immediate debts. However, an excessively high ratio might imply inefficient use of assets. A ratio below 1.0 signals potential difficulty meeting short-term obligations.

Higher profitability ratios, such as net profit margin or ROE, are generally favorable, indicating better efficiency in generating earnings or returns. Comparing these margins to competitors can reveal competitive advantages or weaknesses. Declining margins over time may warrant investigation into costs or market pressures.

Efficiency ratios, like inventory turnover, provide insights into operational management. High inventory turnover often suggests strong sales, but extremely high turnover could risk stockouts. Low turnover might indicate weak sales or overstocking. Interpretation depends heavily on industry norms.

Leverage ratios, including debt-to-equity, reveal a company’s reliance on debt. Lower ratios usually imply lower financial risk. Higher ratios indicate greater leverage, which can boost returns but also increases risk if earnings fall. An interest coverage ratio significantly above 1 indicates a better capacity to meet interest payments. Acceptable leverage varies by industry.

Valuation ratios like P/E help gauge market perception. A high P/E might suggest expectations of strong growth or potential overvaluation. A low P/E could imply undervaluation or lower growth prospects. Comparing these ratios against industry averages and historical levels helps determine relative value.

Ultimately, interpreting any ratio involves considering it alongside other financial data, qualitative factors, and relevant benchmarks to form a comprehensive view of a company’s financial health.