1. Liquidity Ratios

Liquidity ratios measure a business's ability to meet its short-term obligations. They are important to creditors, suppliers, and banks.

Current Ratio

$\text{Current Ratio} = \frac{\text{Total Current Assets}}{\text{Total Current Assets}}$

• Ideal ratio: 1:1 or higher
• A ratio of 2.75:1 means current assets are 2.75 times current liabilities

Quick Ratio (Acid-Test Ratio)

$\text{Quick Ratio} = \frac{\text{Current Assets} - \text{Inventories} - \text{Prepayments}}{\text{Current Liabilities}}$

• Excludes least liquid assets (inventory and prepayments)
• Ideal ratio: 1:1 or higher

2. Profitability Ratios

Profitability ratios measure the ability to generate profit from operations. They interest owners, managers, and investors.

Gross Profit Margin

$\text{Gross Profit Margin} = \frac{\text{Gross Profit}}{\text{Net Sales}} \times 100\%$

• Shows profit after deducting cost of goods sold
• Higher is better

Operating Profit Margin

$\text{Operating Profit Margin} = \frac{\text{EBIT (Profit before Interest and Tax)}}{\text{Net Sales}} \times 100\%$

Net Profit Margin

$\text{Net Profit Margin} = \frac{\text{Profit After Tax}}{\text{Net Sales}} \times 100\%$

Return on Assets (ROA)

$\text{ROA} = \frac{\text{EBIT}}{\text{Total Assets}} \times 100\%$

Return on Equity (ROE)

$\text{ROE} = \frac{\text{Profit After Interest and Tax}}{\text{Shareholders' Equity}} \times 100\%$

Return on Capital Employed (ROCE)

$\text{ROCE} = \frac{\text{EBIT}}{\text{Capital Employed}} \times 100\%$

Where: Capital Employed = Total Assets - Current Liabilities Or: Capital Employed = Share Capital + Reserves + Long-term Debt

3. Efficiency Ratios (Activity Ratios)

Efficiency ratios measure how effectively a business uses its assets.

Inventory Turnover Ratio

$\text{Inventory Turnover} = \frac{\text{Cost of Goods Sold}}{\text{Average Inventory}}$

Days' Sales in Inventory

$\text{Days' Sales in Inventory} = \frac{365\text{ days}}{\text{Inventory Turnover}}$

Debtors' Turnover Ratio

$\text{Debtors' Turnover} = \frac{\text{Net Credit Sales}}{\text{Average Debtors}}$

Debtors' Collection Period

$\text{Collection Period} = \frac{365\text{ days}}{\text{Debtors' Turnover}}$

Creditors' Turnover Ratio

$\text{Creditors' Turnover} = \frac{\text{Net Credit Purchases}}{\text{Average Creditors}}$

Total Assets Turnover

$\text{Assets Turnover} = \frac{\text{Net Sales}}{\text{Total Assets}}$

4. Financial Leverage Ratios (Solvency Ratios)

Financial leverage ratios assess a business's ability to meet long-term obligations.

Total Debt Ratio

$\text{Debt Ratio} = \frac{\text{Total Liabilities}}{\text{Total Assets}} \times 100\%$

Equity Ratio (Proprietary Ratio)

$\text{Equity Ratio} = \frac{\text{Total Equity}}{\text{Total Assets}} \times 100\%$

Debt-to-Equity Ratio

$\text{Debt-to-Equity} = \frac{\text{Long-term Debt}}{\text{Total Equity}} \times 100\%$

Interest Coverage Ratio

$\text{Interest Coverage} = \frac{\text{EBIT}}{\text{Interest Expenses}}$

• Higher is better; below 1 indicates difficulty in paying interest
• Ratio of 2 or higher is generally adequate