LIQUIDITY RATIO – ability to meet short-term obligations

Higher than 1, solvent or able to pay debts

1. Current ratio – ability to pay current obligations. The higher the ratio, the better it can pay
because assets take a larger portion as compared to the liabilities. (The more predictable the cash
flow, the lower the accepted current ratio)

2. Quick Ratio – more reliable measure because it only focuses on the most liquid assets like cash,
receivables and short term investments. Inventory is deducted if it takes up a huge part of the
assets and is not liquid or not easily convertible to cash. The higher the ratio, the better, but
depends on the nature of business.

ACTIVITY RATIO – the speed with which accounts are converted to cash/sales (inflow or outflow)

1. Inventory turnover – the number of times inventory is sold and replaced in a period. Higher
ratio indicated that the company is efficient in selling its goods. Longer time would increase
financial costs ad storage cost.

2. Average Age of Inventory – the number of days it takes to convert inventory to sales. A lower
ratio is favorable since it signifies that products are sold at a shorter period and thus a higher
profit/revenue flows to the business.

3. Average Collection Period – the time it takes to collect Accounts Receivable or the number of
days sales remain uncollected. A lower ratio means that the firm is effective in collecting
payments from customers within a short period of time, in turn increasing cash flows. The ratio
depends on the credit terms.

4. Average Payment Period – the time it takes for the firm to pay its obligations. Useful for lenders
because it can assess the business’ bill payment patterns. If the company pays within the credit
terms, it means that it has a high credit rating. A lower ratio is expected; late payments will
discourage creditors.

5. Accounts Receivable Turnover – The number of times A/R is turned over in a year. It shows the
efficiency of the company to collect debts from customers. A higher turnover rate indicates that
there is a briefer time between sales and collection of cash.

6. Total Asset Turnover – The efficiency with which the company uses its assets to generate sales.
A higher turnover demonstrates efficiency in the use of assets and firm’s operations.

PROFITABILITY RATIO – measures the profit generated in relation to the level of sales, level of
assets assets, investment, expenses and costs. Without profits, firm cannot attract outside capital
from investors and creditors.

1. Gross Profit Margin – the percentage of sales remaining after all goods have been paid. A higher
margin shows that there is a higher profit percentage in selling one’s goods (low merchandise
cost) and more money is left for payment of other expenses.

2. Operating Profit Margin – the percentage of sales remaining after costs except for taxes, interest
and preferred stock dividends have been paid. It represents pure profits since earnings stem
from the operation of the business alone.
 3. Net Profit Margin – the percentage of sales remaining after all costs have been deducted. It is a
measure of firm’s success with respect to the earnings on sales. It differs across industries. A
higher ratio means that there is a higher conversion of sales to profit.

4. Return on Total Assets – measures the effectiveness of the business in managing assets to
generate profits. (6.1% = 6.1 cents per dollar of asset investment)

5. Earnings Per Share – the number of dollars earned during the period on behalf of each share of
common stock outstanding. It is an indicator of corporate success and is important for potential
stockholders and the management.

6. Return on Equity – the return earned on common stockholders’ investment in the firm.
Owners are better of with a higher return.

DEBT RATIO – the amount of other people’s money used to generate profits.

1. Debt Ratio – assets financed by firm’s creditors. Higher ratio means that one is effective in
using debts to generate profit (higher debt, higher financial leverage – risk and return).
Lower ratio indicates that there is a lower overall debt or the company is not effective in using
the money lent. It depends on your perspective.

2. Times Interest Earned – the ability to pay interest obligations. A ratio between 3 to 5 is
preferred.

3. Fixed-payment Ratio - the ability to fulfill fixed payments such as loans, principal, lease
payment and stock dividends. It also measures risk. The higher the ratio, the lower the risk.