Weeks 3-4: Financial Metrics and Analysis

What are Financial Metrics?

Financial metrics are used to evaluate and assess the financial performance, health, and stability
of a company or an investment. These metrics are derived from a company's financial statements,
such as the balance sheet, income statement, and cash flow statement. They help investors,
analysts, and management make informed decisions regarding the company's operations,
financial position, and future prospects.

Common examples of financial metrics include revenue, net income, earnings per share (EPS),
return on investment (ROI), return on equity (ROE), price-to-earnings (P/E) ratio, and debt-to-
equity ratio. By analyzing these metrics, stakeholders can gain insights into a company's
profitability, efficiency, liquidity, solvency, and overall financial performance.

Grow your business and monitor your fiscal accounting health

Whether you are a successful Fortune 1000 enterprise or an ambitious startup, success depends
on generating revenue and managing your key financial metrics. Stakeholders, investors, and
customers look to financial data and KPIs to assess the performance and viability of your
business model.

Use these financial KPIs and ratios to create dashboards to track the health of your business.

What are the top 3 key financial metrics in any company?

There are 3 top financial metrics that are important in every company: revenue, net profit, and
burn rate.

Revenue is the income generated through your business’ primary operations, often referred to as
the “top line.” Net profit is the dollar value that remains after all expenses are subtracted from
your company’s total income, often referred to as the “bottom line.” Net burn, or burn rate, is
the amount of money a company loses per month as they burn through cash reserves.

Here are the key financial metrics and KPIs that you can add to a dashboard to track the financial
health of your business.

Best Financial Metrics

The top KPIs for modern finance and accounting teams:

 Current Ratio

 Gross Margin

 Net Burn

 Net Profit

 Revenue

 Earnings Before Interests, Taxes, Depreciation, and Amortization (EBITDA)

 Annual Recurring Revenue

 CAC Payback Period

 Customer Lifetime Value

  Revenue Per Employee

 MRR Growth Rate

As we wrap up our exploration of financial metrics and KPIs, it's crucial to remember that
keeping a close eye on these indicators is the key to unlocking insights into your organization's
financial well-being. By staying in tune with these metrics, you'll be better equipped to make
strategic decisions that foster growth and financial stability.

To further your knowledge and expertise in KPI analysis and implementation, we invite you to
check out our extensive resource on KPI examples & templates. This handpicked collection
showcases a variety of visual examples and easy-to-adapt templates aimed at helping you
effectively measure, analyze, and enhance your organization's financial performance.

The Accounts Payable Turnover is a KPI that measures the rate your company pays off suppliers
and other expenses. This is an important indicator for understanding your company’s liquidity
and ability to manage cash, by reflecting the number of times your business paid off its accounts
payable and short-term debt over the course of a period of time (month, quarter, year). This ratio
is often used in conjunction with Current Ratio or Quick Ratio, for a well rounded assessment of
your company’s liquidity. Overall, a high ratio is good and indicates that a business pays its bills
and suppliers on time.

Formula

Accounts Payable Turnover Ratio = (Total Purchases / Average Accounts Payable)

Note: Total purchases is often a reflection of COGS on the Income Statement, and Accounts
Payable is on the Balance Sheet.

Example of Accounts Payable Turnover Ratio

XYZ Company purchased $5,000 of materials in 2021. Its account payable at the end of 2020
and 2021 is 2,000 and 3,000 respectively.

Account Payable Turnover Ratio = [5,000/(2,000+3,000)/2] = 2.0

This means that on average company XYZ paid its average accounts payable twice during 2021.

 Explore revenue and profitability metrics.

3 Profit Metrics Every Investor Should Understand
When investors want to see how a company is performing, chances are they’ll browse the
company’s website or annual report for its income statement. One sees the business’s total
revenue at the top, followed by several rows of expenses. At the bottom of the income
statement is the company's net income or net profit or loss. If this number is bigger than last
year’s, one might presume the firm is doing better. But is it?
As it turns out, an organization's performance is a little more complex than its renowned
bottom line. That’s why most analysts look at more than one form of profit when evaluating
a stock. In addition to the net profit, they may also factor in gross profit and operating profit.
Each of these line items on the income statement has important information about how the
company is doing. If the investor knows what to look for, the different measures of profit can
help indicate whether recent trends—good or bad—are likely to continue.
KEY TAKEAWAYS
 Three distinct profitability metrics can be found on a company's income statement.
 Gross profit represents the profit earned from the production of its goods and services and
equals revenue minus the cost of goods sold.
 Operating profit represents gross profit minus operating expenses, which include sales,
general, and administrative expenses or overhead.
 Net profit represents the bottom-line profit after all expenses have been subtracted from
revenue, including taxes and interest on debt.
The 3 Major Profits
To analyze all three-profit metrics, it’s important to understand the income statement, which
shows a company’s revenue and expenses for a specific period, such as a quarter or a full
year. If it’s a publicly traded company, investors can find its financial statements on the
company’s investor relations webpage.
For illustrative purposes, let's consider a fictitious example of a toy company called Active
Tots, a manufacturer of outdoor children’s toys. Below is the company's full-year income
statement.
(in millions) 2023 2022
Net Sales 2,00 1,80
0 0
Cost of Goods Sold (900 (700
) )
Gross Profit 1,10 1,10
0 0
Operating Expenses (SG&A) (400 (250
) )
Operating Profit 700 850
Other Income (Expense) (100 50
)
Extraordinary Gain (Loss) 400 (100
)
Interest Expense (200 (150
) )
Net Profit Before Taxes (Pretax 800 650
Income)
Taxes (250 (200
) )
Net Profit 550 450
Gross Profit
The top line of the table shows the company’s revenue or net sales—in other words, all the
revenue it has generated over a given stretch of time from its day-to-day operations. From
this initial sales figure, the business subtracts all the expenses associated with actually
producing its toys, from raw materials to the wages of people working in its factory. These
production-related expenditures are referred to as the “cost of goods sold." The remaining
amount, usually on line 3, is the gross profit.
Operating Profit
The next row down shows the business’s operating expenses, or SG&A, which stands
for selling, general and administrative expenses. Essentially, these are its "overhead."
Companies can’t just make products and collect the proceeds. They need to hire salespeople
to bring the goods to market and executives who help chart the organization’s direction.
Usually, they’ll also pay for advertising as well as the cost of any administrative buildings.
All of these items are included in the operating expense figure. Once this is subtracted from
gross profit, we arrive at the operating profit.
Net Profit
Toward the bottom of the income statement are expenses not related to the firm’s core
business. For example, there’s a line for extraordinary gains or losses, which include unusual
events such as the sale of a building or business unit. Here, we also see any gains or losses
from investments or interest expenses. Finally, the document includes a line representing the
corporation’s tax expense. Once these additional expenses are deducted from operating
profit, the investor arrives at the net income or net profit—or net loss, if that’s the case. This
is the amount of money the company has either added to or subtracted from its coffers over a
given time period.
Understanding the Differences
So why use these different metrics? Let’s examine the Active Tots income statement to find
out. Many beginning investors will naturally look right for the net profit line. In this case, the
company earned $550 million in its latest fiscal year, up from $450 million the year before.
On the surface, this looks like a positive development. However, a closer look reveals some
interesting information. As it turns out, the firm’s gross profit—again, the revenue that
remains after subtracting production expenses—is the same from one year to the next. In fact,
the cost of goods sold grew at a faster pace than net sales. There could be any number of
reasons for this. Perhaps the cost of plastic, a primary material in many of its products, rose
significantly. Or, perhaps, its unionized plant workers negotiated for higher wages.
What is perhaps more interesting is that the business’s operating profit actually went down in
the latest year. This may be a sign that the company’s staff is becoming bloated, or that
Active Tots has failed to rein in employee perks or other overhead expenses.
How, then, is the company earning $100 million more in net profit? One of the biggest
factors appears toward the bottom of the income statement. Last year, Active Tots recorded
an extraordinary $400 million gain. In this case, the one-time windfall was the result of
selling its educational products division.
While the sale of this business unit increased net profit, it’s not income the company can
count on year after year. For this reason, many analysts emphasize operating profit, which
captures the performance of a firm’s core business activity, over net profit.
It’s important to note, however, that not all spending increases are negative. For example, if
Active Tots saw its operating expenses shoot up as a result of a new advertising campaign,
the firm might more than make up for it the following year with increased revenue. In
addition to looking at the income statement, it’s important to read up on the company to find
out why figures are changing.

Evaluating Performance
Profit metrics can help assess a company’s health in two ways. The first is to use them for an
internal review—in other words, comparing new numbers to the firm’s historical data. A
knowledgeable investor will look for trends that help predict future performance. For
instance, if the costs associated with production have risen faster than the company’s sales
over multiple years, it may be difficult for the company to maintain healthy profit
margins going forward. By contrast, if its' administrative expenses start to take up a smaller
part of revenue, the company is probably doing some belt-tightening that will enhance
profitability.
Investors should also compare these three metrics—gross profit, operating profit, and net
profit—to those of a company's competitors. Many investors look at earnings per
share figures, which are based on net profit, when deciding which stocks offer the best value.
However, because one-time gains or expenses can distort financial performance,
many securities analysts will instead key in on operating profit to determine what shares are
worth. Some even advise zooming in on net operating income, another more finely tuned
profit metric that takes into account taxes, but not extraordinary one-time gains or losses.
What Is the Difference Between Profit and Net Income?
Profit refers to the revenue that remains after expenses. It's applied to several levels,
depending on what types of costs are deducted from revenue. Net income, or net profit, on
the other hand, is represented as a single number that reflects a specific type of profit.

What Is the Difference Between Gross Profit and Net Profit?

Gross profit is the remaining income after production costs have been subtracted from
revenue. Net profit, on the other hand, is the profit left after all costs and expenses have been
subtracted from revenue.
What Is Non-Operating Income?
Non-operating income refers to the portion of income that results from activities or items not
related to the main operations of a business, such as interest, investments, and dividends.
The Bottom Line
While it’s tempting to look at the bottom line of an income statement to size up a company,
investors should be mindful of this figure’s shortcomings. Because gross profit and operating
profit focus on the company’s core activities, these numbers are often the best barometer for
determining an organization's future course.

Profitability Ratios: What They Are, Common Types, and How Businesses Use Them
What Are Profitability Ratios?
Profitability ratios are a class of financial metrics that are used to assess a business's ability to
generate earnings relative to its revenue, operating costs, balance sheet assets,
or shareholders' equity over time, using data from a specific point in time. They are among
the most popular metrics used in financial analysis.
Profitability ratios can be a window into the financial performance and health of a business.
Ratios are best used as comparison tools rather than as metrics in isolation.
Profitability ratios can be used along with efficiency ratios, which consider how well a
company uses its assets internally to generate income (as opposed to after-cost profits).
KEY TAKEAWAYS
 Profitability ratios assess a company's ability to earn profits from its sales or operations,
balance sheet assets, or shareholders' equity.
 They indicate how efficiently a company generates profit and value for shareholders.
 Profitability ratios include margin ratios and return ratios.
 Higher ratios are often more favorable than lower ratios, indicating success at converting
revenue to profit.
 These ratios are used to assess a company's current performance compared to its past
performance, the performance of other companies in its industry, or the industry average.
Investopedia / Julie Bang
What Can Profitability Ratios Tell You?
Profitability ratios can shed light on how well a company's management is operating a
business. Investors can use them, along with other research, to determine whether or not a
company might be a good investment.
Broadly speaking, higher profitability ratios can point to strengths and advantages that a
company has, such as the ability to charge more (or less) for products and to maintain lower
costs.
A company's profitability ratios are most useful when compared to those of similar
companies, the company's own performance history, or average ratios for the company's
industry. Normally, a higher value relative to previous value indicates that the company is
doing well.
Return ratios are metrics that compare returns received to investments made by bondholders
and shareholders. They reflect how well a business manages the investments to produce
value for investors.
Types of Profitability Ratios
Profitability ratios generally fall into two categories—margin ratios and return ratios.
Margin ratios give insight, from several different angles, into a company's ability to turn
sales into profit. Return ratios offer several different ways to examine how well a company
generates a return for its shareholders using the money they've invested.
Some common examples of the two types of profitability ratios are:
 Gross margin
 Operating margin
 Pretax margin
 Net profit margin
 Cash flow margin
 Return on assets (ROA)
 Return on equity (ROE)
 Return on invested capital (ROIC)
 Price to sales (P/S) ratio
Margin Ratios
Different profit margins are used to measure a company's profitability at various cost levels
of inquiry. These profit margins include gross margin, operating margin, pretax margin, and
net profit margin. The margins between profit and costs expand when costs are low and
shrink as layers of additional costs (e.g., cost of goods sold (COGS), operating expenses, and
taxes) are taken into consideration.
Gross Margin
Gross profit margin, also known as gross margin, is one of the most widely used profitability
ratios. Gross profit is the difference between sales revenue and the costs related to the
products sold, the aforementioned COGS. Gross margin compares gross profit to revenue.
A company with a high gross margin compared to its peers likely has the ability to charge a
premium for its products. It may indicate the company has an important competitive
advantage. On the other hand, a pattern of declining gross margins may point to increased
competition.
Some industries experience seasonality in their operations. For example, retailers typically
experience significantly higher revenues and earnings during the year-end holiday season.
Thus, it would be most informative and useful to compare a retailer's fourth-quarter profit
margin with its (or its peers') fourth-quarter profit margin from the previous year.
Operating Margin
Operating margin is the percentage of sales left after accounting for COGS as well as normal
operating expenses (e.g., sales and marketing, general expenses, administrative expenses). It
compares operating profit to revenue.
Operating margin can indicate how efficiently a company manages its operations. That can
provide insight into how well those in management keep costs down and maximize
profitability.
A company with a higher operating margin than its peers can be considered to have more
ability to handle its fixed costs and interest on obligations. It most likely can charge less than
its competitors. And it's better positioned to weather the effects of a slowing economy.
Pretax Margin
The pretax margin shows a company's profitability after accounting for all expenses
including non-operating expenses (e.g., interest payments and inventory write-offs), except
taxes.
As with other margin ratios, pretax margin compares revenue to costs. It can signal
management's ability to run a business efficiently and effectively by boosting sales as it
lowers costs.
A company with a high pretax profit margin compared to its peers can be considered a
financially healthy company with the ability to price its products and/or services most
appropriately.
Net Profit Margin
The net profit margin, or net margin, reflects a company's ability to generate earnings after
all expenses and taxes are accounted for. It's obtained by dividing net income into total
revenue.
Net profit margin is seen as a bellwether of the overall financial well-being of a business. It
can indicate whether company management is generating enough profit from its sales and
keeping all costs under control.
Its drawback as a peer comparison tool is that, because it accounts for all expenses, it may
reflect one-time expenses or an asset sale that would increase profits for just that period.
Other companies won't have the same one-off transactions. That's why it's a good idea to
look at other ratios, such as gross margin and operating margin, along with net profit margin.
Cash Flow Margin
The cash flow margin measures how well a company converts sales revenue to cash. It
reflects the relationship between cash flows from operating activities and sales.
Cash flow margin is a significant ratio for companies because cash is used to buy assets and
pay expenses. That makes the management of cash flow very important. A greater cash flow
margin indicates a greater amount of cash that can be used to pay, for example, shareholder
dividends, vendors, and debt payments, or to purchase capital assets.
A company with negative cash flow is losing money despite the fact that it's producing
revenue from sales. That can mean that it might need to borrow funds to keep operating.
A limited period of negative cash flow can result from cash being used to invest in, e.g., a
major project to support the growth of the company. One could expect that that would have a
beneficial effect on cash flow and cash flow margin in the long run.
Return Ratios
Return ratios provide information that can be used to evaluate how well a company generates
returns and creates wealth for its shareholders. These profitability ratios compare investments
in assets or equity to net income. Those measurements can indicate a company's capability to
manage these investments.
Return on Assets (ROA)
Profitability is assessed relative to costs and expenses. It's analyzed in comparison
to assets to see how effective a company is at deploying assets to generate sales and profits.
The use of the term "return" in the ROA measure customarily refers to net profit or net
income—the value of earnings from sales after all costs, expenses, and taxes. ROA is net
income divided by total assets.
The more assets that a company has amassed, the greater the sales and potential profits the
company may generate. As economies of scale help lower costs and improve margins,
returns may grow at a faster rate than assets, ultimately increasing ROA.
Return on Equity (ROE)
ROE is a key ratio for shareholders as it measures a company's ability to earn a return on its
equity investments. ROE, calculated as net income divided by shareholders' equity, may
increase without additional equity investments. The ratio can rise due to higher net income
being generated from a larger asset base funded with debt.
A high ROE can be a sign to investors that a company may be an attractive investment. It can
indicate that a company has the ability to generate cash and not have to rely on debt.
Return on Invested Capital (ROIC)
This return ratio reflects how well a company puts its capital from all sources (including
bondholders and shareholders) to work to generate a return for those investors. It's
considered a more advanced metric than ROE because it involves more than just shareholder
equity.
ROIC compares after-tax operating profit to total invested capital (again, from debt and
equity). It's used internally to assess appropriate use of capital. ROIC is also used by
investors for valuation purposes. ROIC that exceeds the company's weighted average cost of
capital (WACC) can indicate value creation and a company that can trade at a premium.
What Are the Most Important Profitability Ratios?
The profitability ratios often considered most important for a business are gross margin,
operating margin, and net profit margin.
Why Are Profitability Ratios Significant?
They're significant because they can indicate the ability to make regular profits (after
accounting for costs), and how well a company manages investments for a return for
shareholders. They can reflect management's ability to achieve these two goals, as well as the
company's overall financial well-being.
How Is Business Profitability Best Measured?
The gross profit margin and net profit margin ratios are two commonly used measurements
of business profitability. Net profit margin reflects the amount of profit a business gets from
its total revenue after all expenses are accounted for. Gross profit margin indicates profit that
exceeds the cost of goods sold.
The Bottom Line
Profitability ratios offer companies, investors, and analysts a way to assess various aspects of
a company's financial health. There are two main types of profitability ratios: margin ratios
and return ratios.
Margin ratios measure a company's ability to generate income relative to costs. Return ratios
measure how well a company uses investments to generate returns—and wealth—for the
company and its shareholders.

 Analyze gross profit, operating profit, and net profit.

Gross vs. Operating vs. Net Profit: 4 Key Differences
Profit occurs when a company's sales revenue exceeds expenses. There are three main types
of profit — gross profit, operating profit and net profit. If you work in accounting,
understanding these three concepts is essential for analyzing the financial health of your
organization and devising sound approaches to achieving revenue goals.In this article, we
define gross versus operating versus net profit, along with their respective formulas and
profit margins and examine the four key differences between them.
Key takeaways:
 Gross profit is the amount a business has earned minus the direct costs of manufacturing
or the cost of goods sold.
 Operating profit is the amount of the gross profit minus operational costs.
 Net profit is the total amount left over after the business has accounted for all deductions,
including interest and taxes.
 Gross and net profit are standard inclusions on an income statement, but businesses
commonly leave out their operating profit.
 Each type of profit provides a different set of information about a business's financial
health.
What is gross profit?
Gross profit represents a business' earnings after deducting manufacturing costs. Retail
companies calculate gross profits by subtracting the cost of goods sold (COGS) from total
sales. They then record these values as the first line item on their income statements.
Calculating gross profit tells a company whether its production and pricing are efficient
enough to meet revenue goals.

Gross profit formula

Calculate gross profit by subtracting COGS from the total sales revenue. The formula for this
is:
Gross profit = total sales - COGS
Assume, for example, that you have $10,000 in sales and $750 in COGS. This would equal a
gross profit of $9,250.

Gross profit margin

The gross profit margin represents a percentage of sales that you can use to assess the
financial health of your company. Higher gross profit margins can indicate efficient
processes that support productivity and financial gain. Additionally, the gross profit margin
can give your insight into factors affecting revenue generation.
What is operating profit?
Operating profit comes from the total income left after a company subtracts its operating
costs from its gross profits. Operating costs can include direct expenses like sales,
administrative expenses and overhead expenses. Understanding the operational profit gives
businesses deeper insight into productivity and operational efficiency.

Operating profit formula

Operating profit comes from the deduction of indirect expenses from the gross profit,
subtracting costs like administrative, overhead and sales costs. The following formula applies
these values to give you the operating profit: Operating profit = gross profit - indirect or
operational expenses For example, if you retain $25,000 in gross profits and have $8,000 in
operating expenses — like overhead, administrative costs and sales costs — the operating
profit is $17,000.

Operating profit margin

The operating profit margin compares a business' profits against its total sales revenue after
accounting for production expenses. By comparing operating profit with total sales,
businesses can determine how efficiently sales generate profits. Typically, a higher operating
profit margin also means greater production efficiency, likely resulting from effective cost
reduction and product pricing strategies.
What is net profit?
Net profit represents all of the income that a business has left over after deducting its
remaining expenses, including interest and taxes. A business's net profit is usually the last
item on the income statement, showing the total income the business' executives and
shareholders earn.

Net profit formula

To find the net profit, subtract all indirect tax and interest expenses from the operating profit.
The net profit formula is:Net profit = operating profit - (taxes + interest)For instance, if a
business has $15,000 in operating profit, $2,500 in taxes and $1,000 in interest, this results in
a net profit of $11,500.

Net profit margin

The net profit margin measures a company's net profit against the revenue it generates
through sales. The metric is a percentage of total revenues and can indicate how profitable a
company is after it deducts all liabilities and expenses. Typically, the higher the net profit
margin is, the more profitable the company may be.
Gross vs. operating vs. net profit
While each type of profit relates to the others, there are several key differences to consider
when calculating, documenting and applying them toward revenue goals. The four key
differences between these metrics are:

Valuation methods
Because gross profit, net profit and operating profit require different formulas for calculation,
the valuation of the financial metrics for each profit calculation also differs. The distinctions
are as follows:
 Calculating gross profit requires the valuation of various expenses related to COGS,
which may include the costs associated with labor, production materials and inventory.
 Operating profit requires the valuation of all indirect costs, including overhead,
administrative expenses and fixed expenses.
 Net profit depends on the valuation of gross profit and operating profit, and it subtracts
the remaining tax and interest deductions.

Documentation
Gross profit and net profit appear on income statements. The gross profit is typically the first
line item, giving analysts and investors a quick look into a business's ability to generate
revenue. The net profit appears as the bottom line, showing the total earnings a business
generates after accounting for its taxes and interest liabilities. In contrast, the operating profit
sometimes doesn't appear on the income statement, as businesses may choose to subtract all
expenses from gross profit to determine the net profit. Related: Everything You Need To
Know About Income Statements

Analysis and budgeting

Upon analysis, each type of profit provides a different set of information. For example:
 Gross profit can give financial analysts insight into a business to generate sales revenue.
 The operating profit shows how efficiently the business turns those sales into profits.
With this metric, a business can evaluate whether operational costs are meeting budget
objectives, providing a basis on which to form cost reduction and productivity strategies.
 Net profit helps demonstrate the business's efficiency, particularly in analyzing and
setting budgets that cover taxes and annual interest rates.
Strategy development
Understanding financial processes regarding all levels of profit can help you develop
strategies to support improvements across operational, sales and financial activities. Strategy
development can vary because of the differences in the financial analysis of each profit type.
For example:
 With gross profits, managers can look for approaches to reducing the costs of production
and materials.
 Operational profit can help sales teams develop strategies for product prices and
consumer marketing.
 Net profits support strategic planning and implementation in investing and funding
business growth, resulting in continuous financial stability.

 Dive into financial ratios: liquidity, solvency, efficiency, and profitability.

What are financial ratios?
Financial ratios help understand a company’s financial health by comparing different aspects
of financial data. They use data from the company’s balance sheet, such as income
statements.

They view a company’s financial health from multiple angles. Some of them include:

How well a company can pay its debts

How efficient is resource utilization
How good the company is making money
Whether an organization can meet its long-term financial obligations

Types of financial ratios

You can refer to multiple types of financial ratios to make data-driven and informed business
decisions. There are five important financial ratio types:
1. Liquidity ratios
2. Solvency ratios
3. Profitability ratios
4. Efficiency ratios
5. Market value ratios
Let’s dive into their details to understand with more clarity.

1. Liquidity ratios
Liquidity ratios measure a company’s ability to pay off its short-term debts. They show if a
company has enough assets to cover its immediate liabilities. Three main types of liquidity
ratios are the current ratio, quick ratio, and cash ratio. Each ratio offers a different insight
into a company’s short-term financial health.
Current ratio
This ratio compares a company’s assets to its liabilities.
Current Ratio = Current Assets/ Current Liabilities
For example, if a company has ₹100,000 in current assets and ₹50,000 in current liabilities,
its current ratio is 2. This means the company has twice as many assets as liabilities.
Quick ratio
Also known as the acid-test ratio, it’s similar to the current ratio but more stringent. It
excludes inventory from current assets.
Quick Ratio = Current Assets – Inventory/Current Liabilities
If your business has ₹100,000 in current assets, ₹30,000 in inventory, and ₹50,000 in
current liabilities, its quick ratio is 1.4.
It indicates how well you can meet short-term obligations without selling inventory.
Cash ratio
This is the most conservative liquidity ratio. It looks only at cash and cash equivalents
compared to current liabilities.
Cash Ratio = Cash and Cash Equivalents/Current Liabilities
For instance, if you have ₹20,000 in cash and cash equivalents and ₹50,000 in current
liabilities, your cash ratio is 0.4 ( ₹20,000 / ₹50,000). It tells us how much of your
organization’s short-term liabilities can be paid using only cash and near-cash resources.

2. Solvency ratios
Solvency ratios measure a company’s ability to meet its long-term debts and obligations.
They show if a company is financially healthy in the long run. A healthy solvency ratio
indicates a stable company that can sustain operations and grow long-term. Here are a few
key types of solvency ratios:
Debt to equity ratio
This ratio compares a company’s total liabilities to its shareholder equity. It shows how much
the company finances its operations through debt versus its funds.
Debt to equity ratio = Total Liabilities / Total Shareholder’s Equity
If you have ₹2,00,000 in liabilities and ₹1,00,000 in shareholder equity, the debt-to-equity
ratio is 2. It means your business has ₹2 of debt for every rupee of equity. But on its own, it
doesn’t give any concrete information to investors.
Interest coverage ratio
This ratio tells us how well a company can pay the interest on its debt. It’s calculated by
dividing the company’s earnings before interest and taxes (EBIT) by its interest expenses on
its outstanding debts.
Interest Coverage Ratio = EBIT / Interest Expenses
Suppose a company’s EBIT is ₹50,000 and interest expenses are ₹10,000. The interest
coverage ratio would be 5 ( ₹50,000 / ₹10,000), indicating the enterprises can easily cover
their interest payments.
Debt service coverage ratio (DSCR)
DSCR measures the company’s ability to service its debt. It’s calculated by dividing the
company’s net operating income by its total debt service. Debt service is the principal,
interest, or lease payments due for the period.
DSCR = Net Operating Income /Total Debt Service
When your net operating income is ₹120,000, and a total debt service is ₹40,000, the
DSCR is 3. It means the business earns three times more than it needs to cover its debt
payments.

3. Profitability ratios
Profitability ratios show how well a company can generate profits from its operations. These
ratios help investors and managers understand how effectively a company turns revenues into
profits. They are crucial for comparing a company’s financial performance over time or
against competitors.
Here are some common types of profitability ratios:
Gross profit margin
This ratio measures the percentage of revenue that exceeds the cost of goods sold (COGS). It
shows how efficiently a company is producing its goods or services.
Gross Profit Margin = (Revenue – COGS/ Revenue) × 100
If an organization’s revenue is ₹200,000 and COGS is ₹150,000, its gross profit margin is
25%. This means 25% of the revenue is gross profit.
Net profit margin
This ratio shows the percentage of revenue that remains as profit after all expenses are
deducted. It tells us how much profit a company makes for every sales rupee.
Net Profit Margin = (Net Income/ Revenue) × 100
With ₹200,000 in revenue and ₹30,000 as net income, the net profit margin is 15%. This
means 15% of the revenue is your net profit. When you earn ₹1 as revenue, the net profit is
₹0.15.
Return on equity (ROE)
This ratio measures the company’s profitability relative to shareholder equity. It indicates
how well the company uses investments to generate earnings growth. The formula is:
ROE = (Net Income/Shareholder’s Equity) × 100
Suppose you have a net income of ₹30,000 and the shareholders’ equity is ₹100,000; the
ROE is 30%. This shows that you generate a 30% return on the equity.
Return on assets (ROA)
Return on assets shows how well a company uses its assets to profit. It compares your
company’s net income to total assets.
ROA = (Net Income / Total Assets) × 100
For example, if your company has a net income of ₹50,000 and total assets of ₹2,00,000,
ROA is 25%. It means the company generates a profit of ₹0.25 for every ₹1 of assets.

4. Efficiency Ratios
Efficiency ratios show how well a company uses its assets and liabilities to generate revenue
and profits. They tell how effectively a business manages its operations. Here are some
common types of efficiency ratios:
Inventory turnover ratio
This ratio shows how often a company sells and replaces its inventory over time. It helps
understand how efficiently inventory is managed. The formula is:
Inventory Turnover Ratio = Cost of Goods Sold (COGS) / Average Inventory
When COGS is ₹150,000, and the average inventory is ₹30,000, the inventory turnover
ratio is 5. It means the business sold and replaced its inventory five times.
Accounts receivable turnover ratio
This ratio indicates how many times a year a company collects its average accounts
receivable. A higher number shows better collection practices.
Accounts Receivable Turnover Ratio = Net Credit Sales / Average Accounts Receivable
With net credit sales of ₹2,00,000 and average accounts receivable of ₹40,000, the ratio is
5. This means the company collects its receivables five times a year.
Asset turnover ratio
This ratio evaluates how efficiently a company uses its assets to generate sales. It shows the
effectiveness of asset management.
Asset Turnover Ratio = Net Sales/ Average Total Assets
When net sales are ₹500,000 and average total assets are ₹250,000, the asset turnover ratio
is 2. It states each rupee of assets generates ₹2 in sales.

5. Market value ratios

Market value ratios evaluate a company’s financial performance in the stock market. It helps
you understand if a company’s stock valuation is accurate.
Price-earnings (P/E) ratio
This ratio compares a company’s current stock price to earnings per share (EPS). It shows
what the market will pay for each rupee of earnings. You can calculate earnings per share by
dividing the company’s net income by the total number of outstanding shares.
P/E Ratio = Current Share Price / Earnings Per Share (EPS)
If a company’s share price is ₹50 and its EPS is ₹5, the P/E ratio is 10. This means
investors are willing to pay ₹10 for every ₹1 of earnings.
Price-to-book (P/B) ratio
This ratio compares the market value of a company’s shares to its book value. It shows how
much investors are paying for the company’s net assets. You can calculate book value per
share by dividing equity accessible to common shareholders by the total number of
outstanding shares.
P/B Ratio = Current Share Price / Book Value Per Share
If the current share price is ₹50 and the book value per share is ₹25. It means the P/B ratio
is 2. It indicates that the market value is twice the book value.
Dividend yield
This ratio shows how much a company pays out in dividends relative to its share price. It
measures your income for each rupee invested in the company’s stock.
Dividend Yield = (Annual Dividends Per Share / Current Share Price) × 100
Suppose an organization pays annual dividends of ₹2 per share and its share price is ₹40;
the dividend yield is 5%. This means you get a 5% return in dividends on your investment.
How to calculate and interpret financial ratios
There are multiple steps involved when you calculate and interpret financial ratios. These
steps are as follows:
1. Gather financial statements. Collect your company’s financial statements, including
balance sheets, income statements, and cash flow statements.
2. Identify relevant data. Look for the specific numbers needed for each ratio. For
example, you need current assets and liabilities from the balance sheet for the current
ratio.
3. Apply the formula. Leverage ratios formula mentioned above to calculate. For instance,
to calculate the current ratio, divide current assets by current liabilities.
4. Calculate. Perform the math to arrive at the ratio you’re looking for. If current assets are
₹100,000 and current liabilities are ₹50,000, the current ratio is 2.
After following these steps, you’ll have a final ratio needed. But these ratios as standalone
instruments don’t make much sense. Comparing it with your organization’s historical data, or
against industry average will supply the insights you’re seeking.
You need to look for trends over time. Are the ratios improving or declining? Always
consider the business context. For example, a low current ratio in a rapidly growing company
might not be a concern if they invest heavily in growth.

Applications of financial ratios

Multiple industries on the market use financial ratios to determine their company’s
performance and financial health over time.
Retail Industry
Below are the financial ratios people care about in the retail business.
 Inventory turnover tells how fast products sell.
 Gross profit margins help understand pricing strategies and control costs.
 Current and quick ratios indicate if they can pay short-term debts.

Manufacturing Industry
On the manufacturing side, businesses care about efficiency ratios to understand how well
their team uses factory resources. The debt-to-equity ratio helps leaders understand how
much the company relies on debt to finance operations.
On the other hand, return on equity shows how effectively capital is used to generate profit.
Technology Industry
On the tech side, startups and growth-focused companies use cash ratios to understand their
liquidity. Investors take more interest in the P/E ratio to understand market expectations for
growth and earnings.
Related Reads: Financial Planning Tools
Challenges and limitations of financial ratios
While financial ratios are helpful, they should be used cautiously and as part of a broader
analysis. They provide a snapshot of a company’s finances at a specific time, and you
compare them or forecast them to understand historical or future trends. However, these
ratios vary a lot across different sectors.
Financial ratios that don’t complement industry benchmarks don’t always indicate a problem.
These ratios should be a part of a broader financial analysis instead of standalone insights
guiding your decisions.
Conclusion: Toward improving financial health
These ratios offer valuable insights into a company’s financial health and performance. With
an understanding of your liquidity, profitability, and efficiency, you can strive to make
conscious changes to improve in financial matters.
Learn more about how you can perform financial analysis in your organization.
Financial ratios – FAQs
1. What are the 5 types of financial ratios?
Financial ratios are categorized into five main types, including liquidity ratios, profitability
ratios, efficiency ratios, solvency ratios, and market value ratios.
2. What do you mean by financial ratios?
Financial ratios are numerical comparisons derived from a company’s financial statements,
like the balance sheet and income statement. They provide insights into various aspects of a
company’s financial health and performance. These ratios simplify complex financial
information, making it easier to analyze and compare. For instance, profitability ratios reveal
how effectively a company generates profit, while liquidity ratios assess its ability to pay off
short-term debts.
3. Why are financial ratios useful?
Financial ratios are useful because they simplify complex financial data, allowing for easy
comparison and analysis. They help stakeholders assess a company’s financial health,
efficiency, and performance.
4. How are ratios classified?
Ratios are classified based on their financial analysis purpose. Liquidity ratios measure a
company’s ability to pay short-term obligations. Solvency ratios assess long-term debt-
paying ability. Profitability ratios evaluate the efficiency in generating profits. Efficiency
ratios analyze how well a company uses its assets and liabilities.
5. Who uses financial ratios?
Financial ratios are widely used by investors, analysts, creditors, and company management.
Investors and analysts use them to evaluate investment opportunities, creditors to assess
creditworthiness, and management to make strategic business decisions and monitor
operational efficiency.
6. Which financial ratio is most important?
The importance of a financial ratio largely depends on the specific needs and context of the
user. For instance, investors often focus on return on equity (ROE) and price-earnings (P/E)
ratios to assess profitability and value. Creditors might prioritize liquidity ratios like the
current and quick ratios to evaluate a company’s ability to pay short-term debts. On the other
hand, management may emphasize efficiency ratios such as asset turnover to assess
operational effectiveness.
7. How do financial ratios help in analyzing a company’s financial health?
Financial ratios play a crucial role in analyzing a company’s financial health. It simplifies
complex data, simplifies competitive analysis, helps businesses identify trends, and provides
insights to analyze liquidity, profitability, and efficiency.
8. How do you interpret financial ratios in a company’s annual report?
Interpreting financial ratios in a company’s annual report involves several steps:

Identifying key ratios

Calculating ratios
Comparing with industry standards
Analyzing trends
Cross-checking ratios
Considering the economic context
Reading management discussion

 Understand cash flow analysis and its significance.

Cash Flow Analysis: Basics, Benefits and How to Do It
Cash flow is the amount of cash and cash equivalents, such as securities, that a business
generates or spends over a set time period. Cash on hand determines a company’s runway—
the more cash on hand and the lower the cash burn rate, the more room a business has to
maneuver and, normally, the higher its valuation.
Cash flow differs from profit. Cash flow refers to the money that flows in and out of your
business. Profit, however, is the money you have after deducting your business expenses
from overall revenue.

What Is Cash Flow Analysis?

There are three cash flow types that companies should track and analyze to determine the
liquidity and solvency of the business: cash flow from operating activities, cash flow from
investing activities and cash flow from financing activities. All three are included on a
company’s cash flow statement.
In conducting a cash flow analysis, businesses correlate line items in those three cash flow
categories to see where money is coming in, and where it’s going out. From this, they can
draw conclusions about the current state of the business.
Depending on the type of cash flow, bringing in money in isn’t necessarily a good thing.
And, spending money it isn’t necessarily a bad thing.
Key Takeaways
 Cash flow analysis helps you understand how much cash a business generated or used
during a specific accounting period.
 Understanding cash sources and where your cash is going is essential for maintaining a
financially sustainable business.
 A business may be profitable and still experience negative cash flow or lose money and
experience positive cash flow.
 Complementary measurements, such as free cash flow and unlevered free cash flow, offer
unique insights into a company’s financial health.
Cash Flow Analysis Explained
Cash flow is a measure of how much cash a business brought in or spent in total over a
period of time. Cash flow is typically broken down into cash flow from operating activities,
investing activities, and financing activities on the statement of cash flows, a common
financial statement.
While it’s also important to look at business profitability on the income statement, cash flow
analysis offers critical information on the financial health of a company. It tells you if cash
inflows are coming from sales, loans, or investors, and similar information about outflows.
Most businesses can sustain a temporary period of negative cash flows, but can’t sustain
negative cash flows long-term.
Newer businesses may experience negative cash flow from operations due to high spending
on growth. That’s okay if investors and lenders are willing to keep supporting the business.
But eventually, cash flow from operations must turn positive to keep the business open as a
going concern.
Cash flow analysis helps you understand if a business’s healthy bank account balance is from
sales, debt, or other financing. This type of analysis may uncover unexpected problems, or it
may show a healthy operating cash flow. But you don’t know either way until you review
your cash flow statements or perform a cash flow analysis.
In addition to looking at the standard cash flow statement and details, it’s often also useful to
calculate different versions of cash flow to give you additional insights. For example, free
cash flow excludes non-cash expenses and interest payments and adds in changes in working
capital, which gives you a clearer view of operating cash flows. Unlevered free cash flow
shows you cash flow before financial obligations while levered free cash flow explains cash
flow after taking into account all bills and obligations.
Depending on the size of your company, your financial situation, and your financial goals,
reviewing and tracking various forms of cash flow may be very helpful in financial planning
and preparing for future quarters, years, and even a potential downturn in sales or economic
conditions.
Why Is Cash Flow Analysis Important?
A cash flow analysis determines a company’s working capital — the amount of money
available to run business operations and complete transactions. That is calculated as(opens in
new tab) current assets (cash or near-cash assets, like notes receivable) minus current
liabilities (liabilities due during the upcoming accounting period).
Cash flow analysis helps you understand if your business is able to pay its bills and generate
enough cash to continue operating indefinitely. Long-term negative cash flow situations can
indicate a potential bankruptcy while continual positive cash flow is often a sign of good
things to come.
Cash Flow Analysis Basics
Cash flow analysis first requires that a company generate cash statements about operating
cash flow, investing cash flow and financing cash flow.
 Cash from operating activities represents cash received from customers less the amount
spent on operating expenses. In this bucket are annual, recurring expenses such as
salaries, utilities, supplies and rent.
 Investing activities reflect funds spent on fixed assets and financial instruments. These
are long-term, or capital investments, and include property, assets in a plant or the
purchase of stock or securities of another company.
 Financing cash flow is funding that comes from a company’s owners, investors and
creditors. It is classified as debt, equity and dividend transactions on the cash flow
statement.
How Do You Perform Cash Flow Analysis?
To perform a cash flow analysis, you must first prepare operating, investing and financing
cash flow statements. Generally, the finance team uses the company’s accounting software to
generate these statements. Alternately, there are a number of free templates available.(opens
in new tab)
Preparing a Cash Flow Statement
Let’s first look at preparing the operating cash flow statement. The line items that are
factored into the company’s net income and are included on the company’s operating cash
flow statement include but are not limited to:
 Cash received from sales of goods or services
 The purchase of inventory or supplies
 Employees’ wages and cash bonuses
 Payments to contractors
 Utility bills, rent or lease payments
 Interest paid on loans and other long-term debt and interest received on loans
 Fines or cash settlements from lawsuits
There are two common methods used to calculate and prepare the operating activities section
of cash flow statements.
The Cash Flow Statement Direct Method takes all cash collections from operating activities
and subtracts all of the cash disbursements from the operating activities to get the net income.
The Cash Flow Statement Indirect Method starts with net income and adds or deducts from
that amount for non-cash revenue and expense items.
The next component of a cash flow statement is investing cash flow. That bottom line is
calculated by adding the money received from the sale of assets, paying back loans or selling
stock and subtracting money spent to buy assets, stock or loans outstanding.
Finally, financing cash flow is the money moving between a company and its owners,
investors and creditors.
Cash Flow Analysis Example
Net income adjusted for non-cash items such as depreciation expenses and cash
provided for operating assets and liabilities. Using a free public template from the Small
Business Administration (SBA), let’s say Wild Bill’s Dog Trainers and Walkers had a net
income of $100,000 to start and generated additional cash inflows of $220,000.
As you can see in the spreadsheet, it spent $41,000 on operating cash outflows like hiring an
additional person, buying new equipment for the dog park, paying taxes and more. The
owner paid some principal down on a loan and took a draw of $50,000 for an ending cash
balance of $127,200. Small changes in any of those line items show the impact of hiring
more people, paying more taxes, buying more equipment and more to ensure the business has
a healthy balance sheet and doesn’t go “into the red.”
Wild Bill’s Dog Trainers and Walkers

[Mont [Mont [Mon [Mon [Mon [Mon

h] h] th] th] th] th]

Beginning 100,00 $127,2

Cash Balance 0 00

Cash Inflows (Income):

Accts.
Rec.
80,000
Collection
s

Loan
20,000
Proceeds

Sales &
20,000
Receipts

Other:

Total
$120,0
Cash $0 $0 $0 $0 $0
00
Inflows

Available $220,0 $127,2

Cash Balance 00 00

Cash Outflows (Expenses):

 [Mont [Mont [Mon [Mon [Mon [Mon
h] h] th] th] th] th]

Advertisin
100
g

Bank
Service 100
Charges

Credit
500
Card Fees

Delivery 0

Health
4,000
Insurance

Insurance 1,000

Interest 1,000

Inventory
5,000
Purchases

Miscellane
300
ous

Office 200

Payroll 8,000

Payroll
20,000
Taxes

Profession
100
al Fees

Rent or
1,000
Lease

Subscripti
ons & 200
Dues

Supplies 100

Taxes &
100
Licenses
 [Mont [Mont [Mon [Mon [Mon [Mon
h] h] th] th] th] th]

Utilities &
100
Telephone

Other: 0

$41,80
Subtotal $0 $0 $0 $0 $0
0

Other Cash Out Flows:

Capital
0
Purchases

Loan
1,000
Principal

Owner’s
50,000
Draw

Other:

$51,00
Subtotal $0 $0 $0 $0 $0
0

Total
$92,80
Cash $0 $0 $0 $0 $0
0
Outflows

Ending Cash $127,2 $127,2

Balance 00 00

This automated form is made available compliments of CCH Business Owner’s Toolkit

Five Steps to Cash Flow Analysis

There are a few major items to look out for trends and outliers that can tell you a lot about the health of
the business.
1. Aim for positive cash flow
When operating income exceeds net income, it’s a strong indicator of a company’s ability to remain
solvent and sustainably grow its operations.
2. Be circumspect about positive cash flow
On the other hand, positive investing cash flow and negative operating cash flow could signal problems.
For example, it could indicate a company is selling off assets to pay its operating expenses, which is not
always sustainable.
3. Analyze your negative cash flow
When it comes to investing cash flow analysis, negative cash flow isn’t necessarily a bad thing. It could
mean the business is making investments in property and equipment to make more products. A positive
operating cash flow and a negative investing cash flow could mean the company is making money and
spending it to grow.
4. Calculate your free cash flow
What you have left after you pay for operating expenditures and capital expenditures is free cash flow.
This can be used to pay down principal, interest, buy back stock or acquire another company.
5. Operating cash flow margin builds trust
The operating cash flow margin ratio measures cash from operating activities as a percentage of sales
revenue in a given period. A positive margin demonstrates profitability, efficiency and earnings quality.
Cash flow analysis helps your finance team better manage cash inflow and cash outflow, ensuring that
there will be enough money to run—and grow—the business.
Analyze Cash Flow With Software
The math behind a free cash flow analysis can be complex, particularly for large companies or those with
complex finances. However, bookkeeping or accounting software, sometimes part of a larger ERP, take
care of much of the heavy lifting for you. Once your reports are setup in an ERP like Oracle NetSuite,
your cash flow, free cash flow, and other numbers, and the underlying details, are just a few clicks away.
Large companies employ teams of financial planning and analysis (FP&A) professionals who spend their
entire workday digging into the details of financial results looking for patterns and opportunities to
improve results. With a powerful ERP available, much of that process is automated, allowing you to do
more with fewer staff.
Small businesses and large enterprises alike should understand their cash flow and cash position with
regular check-ins. NetSuite helps you achieve better results through automated reporting, machine
learning and AI-driven analysis, and extensive financial analysis tools to give you accurate, timely
information about your business.
Cash Flow Analysis Is Critical for Every Business
Savvy investors would never buy the stock of a company without first looking at its financial statements,
including cash flow. A more detailed cash flow analysis — provided through ERP and advanced
accounting software — offers insights into the financial health and future performance of a business.
Business owners, managers, and executives should look at similar data on their companies on a regular
basis to ensure it’s on track to meet its short-term and long-term financial goals.
Cash flow and cash flow analysis are important for virtually every business. Working without cash flow
knowledge is like a pilot flying blind. Never run your business without updated, accurate cash flow data.
Cash Flow Analysis FAQs
What is cash flow analysis with an example?
Cash flow analysis is a method of reviewing cash flow details for a business. An example may be as
simple as looking at the latest cash flow statement or require more complex calculations, ratios, and
comparisons.
What is the purpose of cash flow analysis?
Cash flow analysis helps business owners, managers, executives, lenders, and shareholders understand if
a company is generating cash or using cash, and the breakdown of where those cash movements are
happening in the company.
How do you analyze cash flow?
Cash flow analysis typically begins with the statement of cash flows, which breaks down cash flows into
sections for operating, financing, and investing activities. Analysis includes looking for trends, areas of
strong performance, cash flow problems, and opportunities for improvement.
What is cash flow software?
Cash flow software is software that helps calculate and analyze cash flow. Bookkeeping software,
accounting software, and ERP software typically include cash flow software modules or components.
What is a cash flow analysis?
Cash flow analysis is a review of business cash flows with a goal of finding trends or opportunities that
allow for improved business decisions and improved long-term growth and sustainability.
What tools do you currently use to manage cash flows?
Most business leaders looking to manage cash flows use their ERP or accounting software as a key tool,
such as Oracle NetSuite. They may also use spreadsheet software to complement analysis and research.