Key Financial Ratios Derived From Accounting Statements

Formula: Current Assets ÷ Current Liabilities

The current ratio is the most widely used liquidity measure. It indicates whether a company holds enough short-term assets — cash, receivables, inventory — to cover obligations due within twelve months. A ratio above 1.0 generally suggests adequate short-term coverage, though the ideal threshold varies significantly by industry. Capital-intensive sectors may operate comfortably below 1.5, while service businesses with thin asset bases may require higher readings.

Data source: both numerator and denominator appear directly on the balance sheet under their respective current sections.

Formula: (Current Assets − Inventory) ÷ Current Liabilities

Also called the acid-test ratio, this metric tightens the liquidity lens by removing inventory — the least liquid current asset — from the numerator. It answers a more conservative question: if sales stopped today, could the company still pay its short-term debts? For businesses where inventory turns slowly or is subject to obsolescence, the quick ratio often provides a more reliable liquidity signal than the current ratio alone.

Both inputs are sourced from the balance sheet. For clarity on terminology, Essential Accounting Terms Every Financially Literate Adult Should Know defines working capital and related concepts.

Formula: Cost of Goods Sold ÷ Average Inventory

Efficiency ratios assess how productively a company manages its assets. Inventory turnover measures how many times inventory is sold and replaced over a period. A higher figure typically indicates strong sales velocity and lean stock management; a declining trend may signal overstocking, slowing demand, or pricing pressure. Cost of goods sold comes from the income statement; average inventory is the mean of opening and closing balances from the balance sheet.

Formula: (Accounts Receivable ÷ Revenue) × 365

This ratio — sometimes called Days Sales Outstanding (DSO) — measures the average number of days a company takes to collect payment after a sale. A lower figure suggests efficient credit management and strong cash conversion. Rising DSO over time may indicate customers are stretching payment terms or that the company is extending credit to riskier buyers to sustain revenue growth. Revenue comes from the income statement; accounts receivable from the balance sheet.

Formula: Total Debt ÷ Total Shareholders' Equity

Leverage ratios quantify reliance on borrowed capital. The debt-to-equity (D/E) ratio compares the total financial obligations a company carries against the equity invested by its owners. A higher ratio indicates greater financial leverage and, correspondingly, greater financial risk — particularly if earnings become volatile. Capital-intensive industries such as utilities and real estate typically carry higher D/E ratios than technology firms. Both inputs are drawn from the balance sheet.

Formula: Earnings Before Interest and Taxes (EBIT) ÷ Interest Expense

Where D/E measures the stock of debt, the interest coverage ratio measures a company's ability to service that debt from current earnings. A ratio of 3.0 means the company earns three times its interest obligations — a common threshold analysts use as a minimum comfort level. Ratios approaching 1.0 suggest earnings barely cover interest costs, leaving little buffer against revenue declines. EBIT and interest expense both appear on the income statement.

Formula: Net Income ÷ Revenue × 100

Net profit margin is the percentage of revenue that survives after all expenses — including taxes, interest, and operating costs — have been deducted. It is one of the most direct measures of profitability and pricing power. Comparing a company's margin against its historical average and industry peers provides more insight than any single-period reading. Both figures are sourced from the income statement.

Formula: Net Income ÷ Average Shareholders' Equity × 100

Return on equity (ROE) measures how efficiently management generates profit from the capital shareholders have invested. It is a key metric for assessing management effectiveness and is frequently used in comparative analysis across companies within the same sector. However, ROE can be mechanically inflated by high leverage — a company borrowing heavily reduces its equity base, which raises ROE without improving underlying operational performance. Net income comes from the income statement; shareholders' equity from the balance sheet.