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Defining Financial Ratios

Running Head: Defining Ratios

Defining Financial Ratios

University of Phoenix

Introduction
There are many ways an investor or a business owner can identify how well or how poorly a company is performing. Each quarter publicly traded companies are required to publish quarterly financial data to the public. Looking at this information, comparing data, and using simple formulas to determine different ratios can save an investor and/or business owner money before things go bad.
Definitions
Current Ratio – this measures the extent to which current assets are available to meet current liabilities (current meaning due within the next 12 months). Current ratio indicates whether the business has enough working capital – i.e. the excess of current liabilities over current assets used to meet short-term obligations, quickly take advantage of opportunities, and qualify for favorable credit terms.
Formula
Current Ratio = Current Assets / Current Liabilities
A ratio 1.0 or greater is considered acceptable for most businesses. A ratio of 2.0 or higher is considered a “high ratio” meaning the company has excessive current assets in the form of inventory and underemployed capital (Business Development Bank of Canada).

Debt Ratio – plain and simple this ratio shows how much a business is in debt, making it an excellent way to check a business’s long term solvency. This ratio identifies how much debt a company carries per dollar of assets (About.com – Small Business Canada, 2008).
Formula
Debt Ratio = Total Debt / Total Assets

Profit Margin – the difference between cost and a selling price of a product or service less operating and overhead cost(s). Profit margin allows a business or investor to identify how profitable a firm is. It identifies profit per dollar of sales (About.com – Small Business Canada, 2008).
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Formula
Profit Margin = Net Income / Sales

Return on Assets (ROA) – this measures how well a company’s management is doing it’s job. A...