Key Financial Ratios for High-Powered Investing

Part of the High-Powered Investing All-in-One For Dummies Cheat Sheet

Financial ratios, or accounting ratios, provide investors with a way of analyzing information in order to evaluate the financial health of a corporation. The values used when calculating ratios come from a corporation’s accounting or financial statements: its balance sheet, income statement, statement of cash flows, and so on.

Following are some common ratios that you see as an investor. These can help you make sense of the information you find in the financial reports you receive.

Ratio Formula Use
Liquidity Ratios
Current ratio Total current assets ÷ Total current liabilities Gives some indication whether a company has enough financial cushion to meet its near-term obligations.
Quick ratio (Current assets – inventory) ÷ Current liabilities Same as current ratio, without including inventory in the calculation. Provides another sign of a company’s strength or weakness.
Operating Ratios
Return on equity (ROE) Net earnings ÷ Owners’ equity Measures how well the company is managing its resources.
Return on assets (ROA) Net earnings ÷ Total assets Reflects the relationship between a company’s profit and the assets used to generate it.
Solvency Ratios
Debt to equity Total debt ÷ Owners’ equity Indicates how dependent a company is on debt.
Debt to assets (or debt ratio) Total debt ÷ Total assets The higher the ratio, the more financial risk the company has assumed.
Valuation Ratios
Price-to-earnings (P/E) Stock price per share ÷ Net earnings per share Clues you in to how much you are paying for the company’s earnings.
Price-to-book (P/B) Stock price (total market cap) ÷ Book value Compares the company’s market value to its accounting (or book) value.
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