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Understanding key ratios and metrics is essential for investors conducting fundamental analysis. These indicators help evaluate a company’s financial health and growth potential, guiding investment decisions.
Profitability Ratios
Profitability ratios measure a company’s ability to generate profit relative to its revenue, assets, or equity. Common ratios include:
- Net Profit Margin: Indicates how much profit is earned from each dollar of revenue.
- Return on Assets (ROA): Shows how efficiently a company uses its assets to generate profit.
- Return on Equity (ROE): Reflects the profitability relative to shareholders’ equity.
Liquidity Ratios
Liquidity ratios assess a company’s ability to meet short-term obligations. Key ratios include:
- Current Ratio: Current assets divided by current liabilities.
- Quick Ratio: (Current assets – Inventory) divided by current liabilities.
Leverage Ratios
Leverage ratios evaluate the degree of a company’s financial leverage and debt levels. Important ratios include:
- Debt-to-Equity Ratio: Total liabilities divided by shareholders’ equity.
- Interest Coverage Ratio: Earnings before interest and taxes (EBIT) divided by interest expenses.
Efficiency Ratios
Efficiency ratios measure how well a company utilizes its assets and manages its operations. Examples include:
- Asset Turnover: Revenue divided by total assets.
- Inventory Turnover: Cost of goods sold divided by average inventory.