Financial ratios are essential tools for evaluating a company’s financial health, performance, and stability within its industry. Investors use them to gain insights into a company’s historical and current financial standing.

Key Ratio Categories:

1. Liquidity Ratios:

   • Purpose: Measure a company’s ability to meet short-term obligations.
   • Current Ratio: Current Assets / Current Liabilities (Indicates short-term solvency).

2. Leverage (Solvency) Ratios:

   • Purpose: Assess a company’s long-term debt-paying ability.
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   • Debt-to-Equity Ratio: Total Debt / Shareholder’s Equity (Indicates long-term solvency).
     
     • Total Debt: Long-term debt + Current liabilities.
     • Shareholder’s Equity: Equity capital + Preference share capital + Retained earnings (profits and reserves).
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   • Interest Coverage Ratio: (EBIT/Interest Expense) (measures the ability to pay interest expenses)

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4. Efficiency (Turnover) Ratios:

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   • Purpose: Evaluate how effectively a company utilizes its assets.
   • Inventory Turnover Ratio: Cost of Goods Sold (COGS) / Average Inventory (Indicates inventory management efficiency).
     
     • Days Inventory Outstanding: 365 / Inventory Turnover Ratio.

5. Profitability Ratios:

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   • Purpose: Measure a company’s ability to generate profits.
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   • Key Metrics:
     
     • Profit After Tax (PAT): Net earnings after taxes.
     • Return on Assets (ROA): (PAT / Total Assets) * 100 (Measures asset utilization).
     • Earnings Per Share (EPS): PAT / Number of Outstanding Shares (Profit per share).
     • Return on Capital Employed (ROCE): (Earnings Before Interest and Taxes (EBIT) / Net Capital Employed) * 100 (Measures operating performance).
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     • Return on Equity (ROE): (PAT / Shareholder’s Equity) * 100 (Measures return on shareholder investment).

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7. Valuation Ratios:

8. • Purpose: Determine a company’s market value relative to its financial performance.
   • Key Metrics:
   • • Price-to-Earnings (P/E) Ratio: Current Market Price (CMP) / EPS.
     • Price-to-Book (P/B) Ratio: Market Price per Share / Book Value per Share.
     • Dividend Yield: Dividends Per Share (DPS) / CMP (Measures dividend return).
     • Enterprise Value-to-EBITDA (EV/EBITDA): EV / EBITDA (Measures company value relative to earnings).
       
       • EV = (Share Price * Number of Shares) + Total Debt – Cash.