A financial ratio or accounting ratio states the relative

magnitude of two selected numerical values taken from an

enterprise's financial statements. Often used in accounting, there
are many standard ratios used to try to evaluate the overall financial
condition of a corporation or other organization. Financial ratios may
be used by managers within a firm, by current and
potential shareholders (owners) of a firm, and by a
firm's creditors. Financial analysts use financial ratios to compare
the strengths and weaknesses in various companies. [1] If shares in a
company are publicly listed, the market price of the shares is used
in certain financial ratios.
Ratios can be expressed as a decimal value, such as 0.10, or given
as an equivalent percentage value, such as 10%. Some ratios are
usually quoted as percentages, especially ratios that are usually or
always less than 1, such as earnings yield, while others are usually
quoted as decimal numbers, especially ratios that are usually more
than 1, such as P/E ratio; these latter are also called multiples.
Given any ratio, one can take its reciprocal; if the ratio was above 1,
the reciprocal will be below 1, and conversely. The reciprocal
expresses the same information, but may be more understandable:
for instance, the earnings yield can be compared with bond yields,
while the P/E ratio cannot be: for example, a P/E ratio of 20
corresponds to an earnings yield of 5%.

Sources of data
Values used in calculating financial ratios are taken from
the balance sheet, income statement, statement of cash flows or
(sometimes) the statement of changes in equity. These comprise
the firm's "accounting statements" or financial statements. The
statements' data is based on the accounting method and accounting
standards used by the organisation.

Purpose and types

Federal debt to Federal revenue ratio

 Financial ratios quantify many aspects of a business and are an
integral part of the financial statement analysis. Financial ratios are
 categorized according to the financial aspect of the business which
the ratio measures.
 Profitability ratios measure the firm's use of its assets and control
of its expenses to generate an acceptable rate of return. [2]
 Liquidity ratios measure the availability of cash to pay debt. [3]
 Efficiency (activity) ratios measure how quickly a firm converts
non-cash assets to cash assets.[4]
 Debt ratios measure the firm's ability to repay long-term debt. [5]
 Market ratios measure investor response to owning a company's
stock and also the cost of issuing stock. [6]
These are concerned with the return on investment
for shareholders, and with the relationship between return and the
value of an investment in company's shares.
Financial ratios allow for comparisons
 between companies
 between industries
 between different time periods for one company
 between a single company and its industry average
Ratios generally are not useful unless they are benchmarked against
something else, like past performance or another company. Thus,
the ratios of firms in different industries, which face different risks,
capital requirements, and competition are usually hard to compare.

Accounting methods and principles

Financial ratios may not be directly comparable between companies
that use different accounting methods or follow various standard
accounting practices. Most public companies are required by law to
use generally accepted accounting principles for their home
countries, but private companies, partnerships and sole
proprietorships may elect to not use accrual basis accounting. Large
multi-national corporations may use International Financial
Reporting Standards to produce their financial statements, or they
may use the generally accepted accounting principles of their home
country.
There is no international standard for calculating the summary data
presented in all financial statements, and the terminology is not
always consistent between companies, industries, countries and
time periods.
 Types of Ratio Comparisons
An important feature of ratio analysis is interpreting ratio values. A
meaningful basis for comparison is needed to answer questions such
as "Is it too high or too low?" or "Is it good or bad?". Two types of
ratio comparisons can be made, cross-sectional and time-series. [7]
Cross-Sectional Analysis
Cross-sectional analysis compares the financial ratios of different
companies at the same point in time. It allows companies to
benchmark from other competitors by comparing their ratio values
to similar companies in the industry.
Time-Series Analysis
Time-series analysis evaluates a company's performance over time.
It compares its current performance against past or historical
performance. This can help assess the company's progress by
looking into developing trends or year-to-year changes.

Abbreviations and terminology

Various abbreviations may be used in financial statements,
especially financial statements summarized on
the Internet. Sales reported by a firm are usually net sales, which
deduct returns, allowances, and early payment discounts from the
charge on an invoice. Net income is always the amount after taxes,
depreciation, amortization, and interest, unless otherwise stated.
Otherwise, the amount would be EBIT, or EBITDA (see below).
Companies that are primarily involved in providing services with
labour do not generally report "Sales" based on hours. These
companies tend to report "revenue" based on the monetary value of
income that the services provide.
Note that Shareholders' Equity and Owner's Equity are not the same
thing, Shareholder's Equity represents the total number of shares in
the company multiplied by each share's book value; Owner's Equity
represents the total number of shares that an individual shareholder
owns (usually the owner with controlling interest), multiplied by
each share's book value. It is important to make this distinction
when calculating ratios.
Abbreviations
(Note: These are not ratios, but values in currency.)
 COGS = Cost of goods sold, or cost of sales.
 EBIT = Earnings before interest and taxes
 EBITDA = Earnings before interest, taxes, depreciation,
and amortization
 EPS = Earnings per share

Ratios
Profitability ratios
Profitability ratios measure the company's use of its assets and
control of its expenses to generate an acceptable rate of return.
Profitability ratios
Name Ratio Notes
Gross margin, Gross profit margin Gross Profit/Net Sales or Net
or Gross Profit Rate[8][9] Sales − COGS/Net Sales
Operating margin, Operating Operating Income/Net Sales Operating
Income Margin, Operating profit income is
[9]
margin or Return on sales (ROS) the
[10]
difference
between
operating
revenues
and
operating
expenses,
but it is
also
sometimes
used as a
synonym
for EBIT
and
operating
profit.[11] Th
is is true if
the firm
has no non-
operating
income.
(Earnings
before
interest
and taxes /
 Sales[12][13])
Profit margin, net margin or net
Net Profit/Net Sales
profit margin[14]
Net Income/Average
Return on equity (ROE)[14] Shareholders Equity
Return on assets (ROA ratio or Du Net Income/Average Total
Pont Ratio)[6] Assets
[15]
Return on assets (ROA) Net Income/Total Assets
Return on assets Du Pont (ROA Du Net Income/Net Sales · Net
Pont)[16] Sales/Total Assets
Net Income/Net Sales · Net
Return on Equity Du Pont (ROE Du Sales/Average
Pont) Assets · Average
Assets/Average Equity
Net Income/Fixed Assets +
Return on net assets (RONA) Working Capital
EBIT(1 − (Tax Rate))/Invested
Return on capital (ROC) Capital
Risk adjusted return on Expected
Expected Return/Economic
Return/Value at
capital (RAROC) Capital
Risk
This is
similar to
(ROI),
which
Return on capital
EBIT/Capital Employed calculates
employed (ROCE)
Net Income
per
Owner's
Equity
Cash flow return on Cash Flow/Market
investment (CFROI) Recapitalisation
Non-Interest
Efficiency ratio expense/Revenue
Similar
to return
on
[17] assets (RO
Basic Earnings Power (BEP) EBIT/Total Assets
A), but
uses EBIT
instead of
net income
Liquidity ratios
Liquidity ratios measure the availability of cash to pay debt.
Liquidity ratios
Name Ratio Notes
Current ratio (Working Capital Current
Assets/Current
Ratio)[18] Liabilities
Current Assets −
[18] (Inventories +
Acid-test ratio (Quick ratio) Prepayments)/Current
Liabilities
Cash and Marketable
Cash ratio[18] Securities/Current
Liabilities
Operating Cash
Operating cash flow ratio Flow/Total Debts
This ratio
assesses a
business's actual
Net working capital to sales Current Assets - liquidity position
Current
ratio[19] Liabilities/Sales against its need
for liquidity,
represented by
its sales.[19]
Similar to the Net
Net Sales/Average
Working Capital Turnover Ratio Working Capital
working capital
to sales ratio
Efficiency ratios
Efficiency ratios measure the effectiveness of the firm's use of
resources.
Efficiency ratios
Name Ratio Notes
Average collection Accounts Receivable/Annual Credit Sales × 365
[4]
period Days
Degree of Operating Percent Change in Net Operating Income/Percent
Leverage (DOL) Change in Sales
Accounts Receivable/Total Annual Sales × 365
DSO Ratio.[20]
Days
Average payment Accounts Payable/Annual Credit Purchases × 365
[4]
period Days
Asset turnover[21] Net Sales/Total Assets
Stock
Cost of Goods Sold/Average Inventory
turnover ratio[22][23]
Receivables
Net Credit Sales/Average Net Receivables
Turnover Ratio[24]
Inventory conversion
365 Days/Inventory Turnover
ratio[5]
Essential
Inventory conversion ly same
Inventory/Cost of Goods Sold × 365 Days
period thing as
above
Receivables
Receivables/Net Sales × 365 Days
conversion period
Payables conversion
Accounts Payables/Purchases × 365 Days
period
(Inventory Conversion Period) +
Cash Conversion
(Receivables Conversion Period) -
Cycle
(Payables Conversion Period)
Debt ratios
Debt ratios quantify the firm's ability to repay long-term debt. Debt
ratios measure the level of borrowed funds used by the firm to
finance its activities.
Debt ratios
Note
Name Ratio
s
Debt ratio[25] Total Debts or Liabilities/Total Assets
Long-term debt to assets
Long-term debt/Total assets
ratio [26]
Debt to equity ratio (gearing (Long-term Debt) + (Value of
ratio)[27] Leases)/(Average Shareholders' Equity)
Long-term Debt to equity (LT
Long-term Debt/Average Shareholders' Equity
Debt to Equity)[27]
Times interest earned ratio EBIT/Annual Interest Expense, or
(Interest Coverage Ratio)[27] equivalently Net Income/Annual Interest
Expense
Debt service coverage ratio Net Operating Income/Total Debt Service
Cash-flow-to-debt ratio Cash Flow from Operations/Total Debt
Market ratios
Market ratios measure investor response to owning a company's
stock and also the cost of issuing stock. These are concerned with
the return on investment for shareholders, and with the relationship
between return and the value of an investment in company's shares.
Debt ratios
 Name Ratio Notes
Earnings per share (EPS)[28] Net Earnings/Number of Shares
Dividends/
Payout ratio[28][29] Dividends/Earnings
EPS
Dividend cover (the inverse
Earnings per Share/Dividend per Share
of Payout Ratio)
P/E ratio Market Price per Share/Diluted EPS
Dividend yield Dividend/Current Market Price
Cash flow ratio or Price/cash Market Price per Share/Present Value of
flow ratio[30] Cash Flow per Share
Price to book value ratio (P/B Market Price per Share/Balance Sheet
or PBV)[30] Price per Share
Price/sales ratio Market Price per Share/Gross Sales
PEG ratio Price per Earnings/Annual EPS Growth
Other ratios
Other ratios
Note
Name Ratio
s
EV/EBITDA Enterprise Value/EBITDA
EV/Sales Enterprise Value/Net Sales
Cost/Income ratio
EV/capacity
EV/output
Capital budgeting ratios
Main article: Capital budgeting
In addition to assisting management and owners in diagnosing the
financial health of their company, ratios can also help managers
make decisions about investments or projects that the company is
considering to take, such as acquisitions, or expansion.
Many formal methods are used in capital budgeting, including the
techniques such as
 Net present value
 Profitability index
 Internal rate of return
 Modified internal rate of return
 Equivalent annuity

See also
 List of financial performance measures
 References
External links
 Stock Valuation Metrics

Financial statement analysis (or just financial analysis) is the

process of reviewing and analyzing a company's financial
statements to make better economic decisions to earn income in
future. These statements include the income statement, balance
sheet, statement of cash flows, notes to accounts and a statement
of changes in equity (if applicable). Financial statement analysis is a
method or process involving specific techniques for evaluating risks,
performance, valuation, financial health, and future prospects of an
organization.[1]
It is used by a variety of stakeholders, such as credit and equity
investors, the government, the public, and decision-makers within
the organization. These stakeholders have different interests and
apply a variety of different techniques to meet their needs. For
example, equity investors are interested in the long-term earnings
power of the organization and perhaps the sustainability and growth
of dividend payments. Creditors want to ensure the interest and
principal is paid on the organizations debt securities (e.g., bonds)
when due.
Common methods of financial statement analysis include horizontal
and vertical analysis and the use of financial ratios. Historical
information combined with a series of assumptions and adjustments
to the financial information may be used to project future
performance. The Chartered Financial Analyst designation is
available for professional financial analysts.

History
Benjamin Graham and David Dodd first published their influential
book "Security Analysis" in 1934.[2] [3] A central premise of their book
is that the market's pricing mechanism for financial securities such
as stocks and bonds is based upon faulty and irrational analytical
processes performed by many market participants. This results in
the market price of a security only occasionally coinciding with
 the intrinsic value around which the price tends to fluctuate.
[4]
Investor Warren Buffett is a well-known supporter of Graham and
Dodd's philosophy.
The Graham and Dodd approach is referred to as Fundamental
analysis and includes: 1) Economic analysis; 2) Industry analysis;
and 3) Company analysis. The latter is the primary realm of financial
statement analysis. On the basis of these three analyses the
intrinsic value of the security is determined.[4]

Horizontal and vertical analysis

Horizontal analysis compares financial information over time,
typically from past quarters or years. Horizontal analysis is
performed by comparing financial data from a past statement, such
as the income statement. When comparing this past information one
will want to look for variations such as higher or lower earnings. [5]
Vertical analysis is a percentage analysis of financial statements.
Each line item listed in the financial statement is listed as the
percentage of another line item. For example, on an income
statement each line item will be listed as a percentage of gross
sales. This technique is also referred to as normalization [6] or
common-sizing.[5]

Financial ratio analysis

Main article: Financial ratio
Financial ratios are very powerful tools to perform some quick
analysis of financial statements. There are four main categories of
ratios: liquidity ratios, profitability ratios, activity ratios and leverage
ratios. These are typically analyzed over time and across
competitors in an industry.
 Liquidity ratios are used to determine how quickly a company can
turn its assets into cash if it experiences financial difficulties or
bankruptcy. It essentially is a measure of a company's ability to
remain in business. A few common liquidity ratios are the current
ratio and the liquidity index. The current ratio is current
assets/current liabilities and measures how much liquidity is
available to pay for liabilities. The liquidity index shows how quickly
a company can turn assets into cash and is calculated by: (Trade
receivables x Days to liquidate) + (Inventory x Days to
liquidate)/Trade Receivables + Inventory.
 Profitability ratios are ratios that demonstrate how profitable a
company is. A few popular profitability ratios are the breakeven
point and gross profit ratio. The breakeven point calculates how
much cash a company must generate to break even with their start
up costs. The gross profit ratio is equal to gross profit/revenue. This
ratio shows a quick snapshot of expected revenue.
 Activity ratios are meant to show how well management is
managing the company's resources. Two common activity ratios are
accounts payable turnover and accounts receivable turnover. These
ratios demonstrate how long it takes for a company to pay off its
accounts payable and how long it takes for a company to receive
payments, respectively.
 Leverage ratios depict how much a company relies upon its debt to
fund operations. A very common leverage ratio used for financial
statement analysis is the debt-to-equity ratio. This ratio shows the
extent to which management is willing to use debt in order to fund
operations. This ratio is calculated as: (Long-term debt + Short-term
debt + Leases)/ Equity.[7]
DuPont analysis uses several financial ratios that multiplied together
equal return on equity, a measure of how much income the firm
earns divided by the amount of funds invested (equity).
A Dividend discount model (DDM) may also be used to value a
company's stock price based on the theory that its stock is worth
the sum of all of its future dividend payments, discounted back to
their present value.[8] In other words, it is used to value stocks based
on the net present value of the future dividends.
Financial statement analyses are typically performed
in spreadsheet software — or specialized accounting software — and
summarized in a variety of formats.

Recasting financial statements

An earnings recast is the act of amending and re-releasing a
previously released earnings statement, with specified intent. [9]
Investors need to understand the ability of the company to generate
profit. This, together with its rate of profit growth, relative to the
amount of capital deployed and various other financial ratios, forms
an important part of their analysis of the value of the company.
Analysts may modify ("recast") the financial statements by adjusting
the underlying assumptions to aid in this computation. For example,
operating leases (treated like a rental transaction) may be recast as
 capital leases (indicating ownership), adding assets and liabilities to
the balance sheet. This affects the financial statement ratios. [10]
Recasting is also known as normalizing accounts. [11]

Certifications
Financial analysts typically have finance and accounting education
at the undergraduate or graduate level. Persons may earn
the Chartered Financial Analyst (CFA) designation through a series
of challenging examinations. Upon completion of the three-part
exam, CFAs are considered experts in areas like fundamentals of
investing, the valuation of assets, portfolio management, and wealth
planning.

Automation
In November 2023, research conducted by Patronus AI, an artificial
intelligence startup company, compared performance of GPT-4, GPT-
4-Turbo, Claude 2, and LLaMA-2 on two versions of a 150-question
test about information in financial statements (e.g., Form 10-K, Form
10-Q, Form 8-K, earnings reports, earnings call transcripts)
submitted by public companies to the U.S. Securities and Exchange
Commission. One version of the test required the generative AI
models to use a retrieval system to find the specific SEC filing to
answer the questions; the other gave the models the specific SEC
filing to answer the question (i.e., in a long context window). On the
retrieval system version, GPT-4-Turbo and LLaMA-2 both failed to
produce correct answers to 81% of the questions, while on the long
context window version, GPT-4-Turbo and Claude-2 failed to produce
correct answers to 21% and 24% of the questions, respectively. [12][13]

See also
 Business valuation
 Financial audit
 Financial statement
 DuPont analysis
 Data analysis

References
External links
 Investopedia
 Beginner's Guide to Financial Statements by SEC.gov
Associations
 SFAF - French Society of Financial Analysts
 ACIIA - Association of Certified International Investment Analysts
 EFFAS - European Federation of Financial Analysts Societies

DuPont analysis is a tool used in financial analysis, where return

on equity (ROE) is separated into its component parts.
Useful in several contexts, this "decomposition" of ROE
allows financial managers to focus on the key metrics of financial
performance individually, and thereby to identify strengths and
weaknesses within the company that should be addressed.
[1]
Similarly, it allows investors to compare the operational
efficiency of two comparable firms.[1]
The name derives from the DuPont company, which began using
this formula in the 1920s. A DuPont explosives salesman, Donaldson
Brown, submitted an internal efficiency report to his superiors in
1912 that contained the formula.[2]

Basic formula
The DuPont analysis breaks down ROE into three component parts,
which may then be managed individually:
 Profitability: measured by profit margin
 Asset efficiency: measured by asset turnover
 Financial leverage: measured by equity multiplier
ROE = (Profit margin)×(Asset turnover)×(Equity multiplier)
= Net profit/Sales×Sales/Average Total Assets×Average Total Assets/Average
Equity = Net Profit/Equity
Or
ROE = Profit/Sales×Sales/Assets = Profit/Assets×Assets/Equity
Or
ROE = ROS×AT = ROA×Leverage

ROE analysis
The DuPont analysis breaks down ROE (that is, the returns that
investors receive from a single dollar of equity) into three distinct
elements. This analysis enables the manager or analyst to
understand the source of superior (or inferior) return by comparison
with companies in similar industries (or between industries).
See Return on equity § The DuPont formula for further context.
The DuPont analysis is less useful for industries such as investment
banking, in which the underlying elements are not meaningful (see
related discussion: Valuation (finance) § Valuing financial services
firms). Variations of the DuPont analysis have been developed for
industries where the elements are weakly meaningful, [citation needed] for
example:
High margin industries
Some industries, such as the fashion industry, may derive a
substantial portion of their income from selling at a higher margin,
rather than higher sales. For high-end fashion brands, increasing
sales without sacrificing margin may be critical. The DuPont analysis
allows analysts to determine which of the elements is dominant in
any change of ROE.
High turnover industries
Certain types of retail operations, particularly stores, may have very
low profit margins on sales, and relatively moderate leverage. In
contrast, though, groceries may have very high turnover, selling a
significant multiple of their assets per year. The ROE of such firms
may be particularly dependent on performance of this metric, and
hence asset turnover may be studied extremely carefully for signs of
under-, or, over-performance. For example, same-store sales of
many retailers is considered important as an indication that the firm
is deriving greater profits from existing stores (rather than showing
improved performance by continually opening stores).
High leverage industries
Some sectors, such as the financial sector, rely on high leverage to
generate acceptable ROE. Other industries would see high levels of
leverage as unacceptably risky. DuPont analysis enables third
parties that rely primarily on their financial statements to compare
leverage among similar companies.

ROA and ROE ratio

The return on assets (ROA) ratio developed by DuPont for its
own use is now used by many firms to evaluate how effectively
 assets are used. It measures the combined effects of profit margins
and asset turnover.[3]

The return on equity (ROE) ratio is a measure of the rate of

return to stockholders.[4] Decomposing the ROE into various factors
influencing company performance is often called the DuPont
system.[5]

Where
 Net Income = pre-tax income after taxes
 Equity = shareholders' equity
 EBIT = Earnings before interest and taxes
 Pretax Income is often reported as Earnings Before Taxes or
EBT
This decomposition presents various ratios used in fundamental
analysis.
 The company's tax burden is (Net income ÷ Pretax profit). This is
the proportion of the company's profits retained after paying income
taxes. [NI/EBT]
 The company's interest burden is (Pretax income ÷ EBIT). This will
be 1.00 for a firm with no debt or financial leverage. [EBT/EBIT]
 The company's operating income margin or return on sales (ROS)
is (EBIT ÷ Revenue). This is the operating income per dollar of sales.
[EBIT/Revenue]
 The company's asset turnover (ATO) is (Revenue ÷ Average Total
Assets).
 The company's equity multiplier is (Average Total Assets ÷
Average Total Equity). This is a measure of financial leverage.

References
External links
 Decoding DuPont Analysis