Financial Statement Analysis Ratios to Know for Financial Accounting II

Financial statement analysis ratios help assess a company's financial health and performance. These ratios, like the current and quick ratios, provide insights into liquidity, profitability, and risk, connecting key concepts from Financial Accounting II and Intermediate Financial Accounting II.

1. Current Ratio

   • Measures a company's ability to pay short-term liabilities with short-term assets.
   • Calculated by dividing current assets by current liabilities.
   • A ratio above 1 indicates that the company has more current assets than current liabilities, suggesting good short-term financial health.

2. Quick Ratio (Acid-Test Ratio)

   • A more stringent measure of liquidity than the current ratio, excluding inventory from current assets.
   • Calculated by dividing liquid assets (current assets - inventory) by current liabilities.
   • A ratio above 1 indicates that a company can cover its short-term obligations without relying on inventory sales.

3. Debt-to-Equity Ratio

   • Indicates the relative proportion of shareholders' equity and debt used to finance a company's assets.
   • Calculated by dividing total liabilities by total equity.
   • A higher ratio suggests greater financial risk, as the company relies more on borrowed funds.

4. Return on Assets (ROA)

   • Measures how efficiently a company uses its assets to generate profit.
   • Calculated by dividing net income by total assets.
   • A higher ROA indicates better asset utilization and profitability.

5. Return on Equity (ROE)

   • Indicates how effectively a company generates profit from its shareholders' equity.
   • Calculated by dividing net income by shareholder equity.
   • A higher ROE suggests that the company is efficient in using equity financing to grow profits.

6. Gross Profit Margin

   • Measures the percentage of revenue that exceeds the cost of goods sold (COGS).
   • Calculated by dividing gross profit by total revenue.
   • A higher margin indicates better efficiency in production and pricing strategies.

7. Net Profit Margin

   • Reflects the percentage of revenue that remains as profit after all expenses are deducted.
   • Calculated by dividing net income by total revenue.
   • A higher net profit margin indicates better overall profitability and cost management.

8. Inventory Turnover Ratio

   • Measures how many times a company's inventory is sold and replaced over a period.
   • Calculated by dividing COGS by average inventory.
   • A higher ratio indicates efficient inventory management and strong sales performance.

9. Accounts Receivable Turnover Ratio

   • Indicates how effectively a company collects its receivables.
   • Calculated by dividing net credit sales by average accounts receivable.
   • A higher ratio suggests efficient credit policies and strong cash flow management.

10. Asset Turnover Ratio

    • Measures how efficiently a company uses its assets to generate sales.
    • Calculated by dividing total revenue by average total assets.
    • A higher ratio indicates effective asset utilization in generating revenue.

11. Price-to-Earnings (P/E) Ratio

    • Reflects investors' expectations of a company's future earnings growth.
    • Calculated by dividing the market price per share by earnings per share (EPS).
    • A higher P/E ratio may indicate that the stock is overvalued or that investors expect high growth rates.

12. Earnings Per Share (EPS)

    • Indicates the portion of a company's profit allocated to each outstanding share of common stock.
    • Calculated by dividing net income by the number of outstanding shares.
    • A higher EPS suggests better profitability and is often used to gauge company performance.

13. Dividend Payout Ratio

    • Measures the proportion of earnings distributed to shareholders as dividends.
    • Calculated by dividing dividends per share by earnings per share (EPS).
    • A lower ratio may indicate that a company is reinvesting more earnings for growth, while a higher ratio suggests a focus on returning profits to shareholders.

14. Interest Coverage Ratio

    • Assesses a company's ability to pay interest on its outstanding debt.
    • Calculated by dividing earnings before interest and taxes (EBIT) by interest expenses.
    • A higher ratio indicates better ability to meet interest obligations, reducing financial risk.

15. Operating Cash Flow Ratio

    • Measures the ability of a company to cover its current liabilities with cash generated from operations.
    • Calculated by dividing operating cash flow by current liabilities.
    • A ratio above 1 indicates that the company generates sufficient cash flow to meet its short-term obligations.