Last updated on August 5th, 2025
In finance, ratio analysis involves using various ratios to evaluate the financial health and performance of a company. These ratios include liquidity, profitability, and efficiency ratios. In this topic, we will learn the formulas for different types of ratio analysis.
To assess financial performance, we use various ratios. Let’s learn the formulas to calculate some key financial ratios.
Liquidity ratios measure a company’s ability to cover its short-term obligations. Key formulas include:
Current Ratio = Current Assets / Current Liabilities
Quick Ratio = (Current Assets - Inventory) / Current Liabilities
Profitability ratios assess a company's ability to generate profit. Key formulas include:
Gross Profit Margin = (Revenue - Cost of Goods Sold) / Revenue Net Profit Margin = Net Income / Revenue
Efficiency ratios measure how well a company uses its assets and liabilities.
Key formulas include:
Inventory Turnover Ratio = Cost of Goods Sold / Average Inventory Asset
Turnover Ratio = Revenue / Average Total Assets
In finance and business, we use ratio analysis formulas to evaluate and understand a company's financial condition. Here are some important aspects of ratio analysis:
Ratios allow for comparison between companies and industry benchmarks.
By learning these formulas, analysts can easily assess financial statements and make informed decisions.
Ratios help identify trends and potential financial issues.
Students often find financial ratios tricky. Here are some tips and tricks to master these formulas: Use mnemonics to remember key formulas, such as "current over current" for the Current Ratio.
Connect the use of ratios with real-life scenarios, like analyzing a company's financial statements.
Create flashcards with ratio names and formulas for quick recall, and develop a formula chart for quick reference.
Analysts make errors when calculating financial ratios. Here are some mistakes and how to avoid them to master ratio analysis.
Calculate the Current Ratio if current assets are $150,000 and current liabilities are $100,000.
The Current Ratio is 1.5
Current Ratio = Current Assets / Current Liabilities = $150,000 / $100,000 = 1.5
If revenue is $250,000 and the cost of goods sold is $150,000, find the Gross Profit Margin.
The Gross Profit Margin is 40%
Gross Profit Margin = (Revenue - Cost of Goods Sold) / Revenue = ($250,000 - $150,000) / $250,000 = $100,000 / $250,000 = 0.4 or 40%
Find the Quick Ratio if current assets are $200,000, inventory is $50,000, and current liabilities are $100,000.
The Quick Ratio is 1.5
Quick Ratio = (Current Assets - Inventory) / Current Liabilities = ($200,000 - $50,000) / $100,000 = $150,000 / $100,000 = 1.5
If a company has a net income of $60,000 and revenue of $300,000, calculate the Net Profit Margin.
The Net Profit Margin is 20%
Net Profit Margin = Net Income / Revenue = $60,000 / $300,000 = 0.2 or 20%
A company has sales of $500,000 and average total assets of $250,000. What is the Asset Turnover Ratio?
The Asset Turnover Ratio is 2
Asset Turnover Ratio = Revenue / Average Total Assets = $500,000 / $250,000 = 2
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