Quick Tip - Common Accounting Ratios

Ratio's can be useful tools when analyzing data. Ratios allow you to test the reasonableness of information underlying the data and they allow you to assess some general assumptions about the profitability or financial strength of an organization.

Liquidity Ratios - Liquidity ratios measure the ability to pay short term obligations. Common liquidity ratios are:

• Current Ratio -- current assets / current liabilities
• Quick (Acid Test) Ratio -- liquid assets / current liabilities
• Current Cash debt Ratio -- Net cash provided by operating / Average current liabilities

Activity Ratios - Activity Ratios measure the turnover, or turn-around time, of an asset and help to understand the overall cash flow cycle. For example faster accounts receivable turnover, the more cash available. Alternatively, the faster the accounts payable turnover, the less cash there is available at any given time. Some common activity ratios are:

• Accounts Receivable Turnover -- Net sales / Average trade receivables (net of allowance)
• Inventory turnover -- Cost of Goods Sold (COGS) / Average inventory
• Asset Turnover -- Net sales / Average total assets

Profitability Ratios - Profitability Ratios measure the degree of success or failure of a given enterprise or division for a particular period of time. Some common profitability ratios are:

• Profit Margin (PM) -- Net income / Net sales
• Return On Assets (ROA) -- Net income / Average total assets
• Return On Common Stock Equity (ROE) -- Net income (less preferred dividends) / Average common shareholder's equity
• Earnings Per Share (EPS) -- net income (less preferred dividends) / Weighted average shares outstanding
• Price Per Earnings (PPE) -- Market price of stock / Earnings per share
• Payout Ratio -- Cash dividends / Net income

Coverage Ratios - Coverage Ratios measure the extent of debt in relation to assets. This ratio is important to investors and creditors because they measure the amount of leveraging. While, a highly leveraged company can be highly profitable, they have a relatively small amount of assets in the event of liquidation. Some common coverage ratios are:

• Debt to Total Assets -- debt / Total assets
• Times Interest Earned (TIE) -- Income before interest and taxes / Interest expense
• Cash Debt Coverage Ratio -- Net cash provided by operating / Average total liabilities
• Book Value Per Share -- Common stockholder's equity / Outstanding shares of common