Financial Ratio Guide

This financial ratio tells an investor how many times a business turns its inventory over a period of time. It allows you to see if a company has too many of its assets tied up in inventory and is heading for financial trouble. A really efficient retailer, for instance, is going to have a higher inventory turnover ratio than a less efficient competitor.

The net profit margin tells you how much money a company makes for every $1 in revenue. Companies with higher net profit margins can often offer better benefits, heftier bonuses, and fatter dividends.

Operating income, or operating profit as it is sometimes called, is the total pre-tax profit a business generated from its operations. It is what is available to the owners before a few other items need to be paid such as preferred stock dividends and income taxes.

The Quick Test Ratio (also called the Acid Test or Liquidity Ratio) is the most excessive and difficult test of a company's financial strength and liquidity.

The receivable turns or receivable turnover is a great financial ratio to learn when you are analyzing a business or a stock because common sense tells you the faster a company collects its accounts receivables, the better. The sooner customers pay their bills, the sooner a company can put the cash in the bank, pay down debt, or start making new products. There is also a smaller chance of losing money to delinquent accounts. Fortunately, there is a way to calculate the number of days it takes for a business to collect its receivables.

Where asset turnover tells an investor the total sales for each $1 of assets, return on assets, or ROA for short, tells an investor how much profit a company generated for each $1 in assets. The return on assets figure is also a sure-fire way to gauge the asset intensity of a business. It is one of the most important financial ratios you can know.

One of the most important profitability metrics is return on equity (or ROE for short). Return on equity reveals how much profit a company earned in comparison to the total amount of shareholder equity found on the balance sheet.

Once you know how to calculate the return on equity financial ratio, you need to go even further and break it down into the various components. This is called the DuPont analysis. By learning it, you can actually see what it is that makes a company profitable. It is, and remains, the secret to understanding most great fortunes.

The working capital per dollar of sales financial ratio is important because it lets you know how much money a company needs to keep on hand to conduct business. Generally speaking, the more working capital a company needs, the less valuable it is because that's money the owners can't take out of the business in the form of dividends.