BUSINESS FINANCE

o Liquidity refers to the ability of the firm to pay its bills on time or to meet its current
obligation.

Types of Liquidity Ratio

1. Current Ratio this ratio indicates the margin of safety by which a firm can meet its
obligations falling due within the year from such assets easily convertible into cash within the
year.
Formula: Current Ratio = current assets/current liabilities
2. Quick Ratio
Formula: Quick Ratio = Cash + Marketable Securities + Accounts Receivable
Current Liabilities

o Profitability are those which measure managements effectiveness as shown by the

returns generated on sales and investment.

Types of Profitability Ratio

1. ROE (Return on Equity) measure the amount of net income earned in relation to
stockholders equity.
Formula: ROE = Net Income + Stockholders Equity
2. ROA (Return on Asset) measures the ability of a company to generate income out of its
resources/assets.
Formula: ROA= Operating Income/Total Assets
3. Gross Profit Margin shows how many pesos of gross profit is earned for every peso of
sale. It provides information regarding the ability of a company to cover its manufacturing cost
from it sales. Remember that gross profit is just sales less cost of goods or cost of services.
Formula: Gross profit/Sales
4. Operating profit margin shows how many pesos of operating profit earned for every
peso of sale. It measures the amount of income generated from the core business of a
company.
Formula: Operating profit margin = Operating income/Sales
5. Net profit margin measures how much net profit a company generates for every peso of
sales or revenues that it generates.
Formula: net profit margin = Net income/Sales

o Efficiency refers to a companys ability to be efficient in its operations. It refers to the

speed with which various current accounts are converted into sales, and ultimately, cash.

Types Efficiency Ratio

1. Accounts Receivable Turnover - Accounts receivable turnover is the number of times per
year that a business collects its average accounts receivable. The ratio is intended to evaluate
the ability of a company to efficientlyissue credit to its customers and collect funds from them in
a timely manner.
Formula: Accounts receivable turnover = Sales/Accounts Receivable
2. Average collection period The average collection period is the approximate amount of
time that it takes for a business to receive payments owed in terms of accounts receivable.
Formula: Average collection period = 365/Accounts Receivable Turnover
3. Inventory Turnover = measure of the number of times inventory is sold or used in a time
period such as a year.
Formula: Inventory turnover = Cost of goods sold/Inventory
4. Average age of inventory the average number of days it takes for a firm to sell off
inventory
Formula: Average age of inventory = 365/Inventory turnover
5. Accounts payable turnover is a ratio that measures the speed with which a company
pays its suppliers
Formula: Accounts payable turnover = Purchases/Inventory
6. Average payment period means the average period taken by the company in making
payments to its creditors.
Formula: Average payment period = 365/Accounts Payable Turnover
7. Operating Cycle is the average period of time required for a business to make an initial
outlay of cash to produce goods, sell the goods, and receive cash from customers in exchange
for the goods.
Formula: Operating Cycle = Average Collection Period + Average Age of Inventory
8. Cash Conversion Cycle is a metric that expresses the length of time, in days, that it
takes for a company to convert resource inputs into cash flows.
Formula: Cash Conversion Cycle = Average Collection Period + Average Age of Inventory
Average Age of payables
Or
Cash Conversion Cycle = Operating cycle - Average Age of payables

o Financial refers to the companys use of debt. It defines the companys capital structure
which indicates how much of the total assets are financed by debt and equity.

Types of Financial Ratio

1. Debt Ratio measures the proportion of total assets finance by total liabilities or money
provided by creditors (not by the business owners)
Formula: Debt ratio = Total Liabilities/Total assets
2. Debt-to-Equity ratio a variation of debt, shows the proportion of debt to equity.
Formula: Debt-to-Equity ratio = Total liabilities/Total Equity
3. Interest Coverage ratio shows the companys ability to pay its fixed interest charges in
relation to its operating income or earnings before interest and taxes.
Formula: Interest Coverage ratio = Earnings before interest and taxes (EBIT)
Interest Expense