Financial Ratios Playbook – Simple Guide for Beginners

Sandeep Chaudhary

Sun, 11 May 2025

Financial ratios are important tools that help you understand the financial health and performance of a company. These ratios are used by investors, business owners, and analysts to make better decisions. The current ratio is one of the most basic ratios. It measures a company’s ability to pay its short-term obligations. The formula is Current Assets divided by Current Liabilities. If the result is above 1, it usually means the company is financially stable in the short term.

The quick ratio, also known as the acid-test ratio, is a stricter version of the current ratio. It checks whether a company can meet short-term liabilities without depending on inventory. The formula is (Current Assets - Inventory) divided by Current Liabilities. A quick ratio above 1 is a good sign of liquidity and financial health.

The debt-to-equity ratio shows how much a company is using debt to finance its operations compared to its own equity. The formula is Total Debt divided by Total Shareholders’ Equity. A high ratio means more reliance on debt, which can be risky, while a low ratio shows the company is less dependent on loans.

The gross profit margin tells how much profit a company makes after deducting the cost of goods sold. It shows how efficiently a company produces or sells its products. The formula is (Revenue - Cost of Goods Sold) divided by Revenue. A high gross margin means the company keeps more money from each sale.

Inventory turnover shows how quickly a company sells its inventory during a period. The formula is Cost of Goods Sold divided by Average Inventory. A high inventory turnover indicates strong sales or efficient inventory management, while a low one may suggest overstocking or weak demand.

Net profit margin measures how much profit a company makes from its total revenue after all expenses. The formula is Net Income divided by Revenue. It reflects the overall profitability of the business. A higher margin means more efficient cost control and better financial performance.

Return on assets (ROA) shows how well a company uses its assets to generate profit. It helps assess how efficiently a company is using its investments in assets. The formula is Net Income divided by Total Assets. A high ROA indicates strong management and efficient asset use.

Accounts receivable turnover shows how quickly a company collects money from its customers. The formula is Net Credit Sales divided by Average Accounts Receivable. A high ratio means the company is collecting payments faster, which is good for cash flow.

Return on equity (ROE) shows how much profit a company earns for every rupee of shareholders’ equity. It measures the return generated on owners' investments. The formula is Net Income divided by Shareholders’ Equity. A high ROE is a positive sign of profitability and value creation.

Accounts payable turnover tells how quickly a company pays its suppliers. It helps measure short-term liquidity and supplier relationships. The formula is 365 divided by Average Number of Days Payable. A low result means faster payments, while a high result shows the company takes longer to pay.

Asset turnover shows how efficiently a company uses its assets to generate revenue. The formula is Net Sales divided by Average Total Assets. A high ratio indicates better performance in turning assets into income.

Operating margin reflects the profit a company makes from its core business operations. It shows how well the company manages its operating costs. The formula is Operating Earnings divided by Revenue. A high operating margin means the company earns more from its core business before interest and tax.

Interest coverage ratio measures how easily a company can pay interest on its debt. The formula is Earnings Before Interest and Taxes (EBIT) divided by Interest Expense. A ratio below 1 indicates financial stress and a risk of default.

Dividend payout ratio shows how much of the company’s earnings are paid to shareholders as dividends. The formula is Dividends Paid divided by Net Income. A low payout means more money is reinvested into the business, while a high payout means more cash returns to shareholders.

Earnings per share (EPS) tells how much net profit is allocated to each share of stock. It is used by investors to compare profitability between companies. The formula is (Net Income - Preferred Dividends) divided by End-of-Period Common Shares Outstanding. Higher EPS means more profit per share and is often linked to rising stock prices.

These financial ratios are essential for analyzing businesses, comparing performance across companies, and making investment decisions. Understanding each formula helps you read financial statements better and evaluate a company’s profitability, liquidity, efficiency, and risk level.