Financial Ratio Analysis Overview
Profitability ratios show you how well a company generates profit from its operations. ROCE (Return on Capital Employed) measures how efficiently a business uses its capital - calculate it by dividing operating profit by total equity plus non-current liabilities. The higher the percentage, the better the company is at generating returns.
Gross Profit Margin (GPM) reveals what percentage of sales revenue remains after covering direct costs. Simply divide gross profit by sales revenue and multiply by 100. Operating Profit Margin goes further by showing profit after all operating expenses, whilst Net Profit Margin shows the final profit percentage after tax.
Gearing ratios help you understand a company's debt levels. Calculate gearing by dividing non-current liabilities by total equity plus non-current liabilities, then multiply by 100. High gearing means more debt, which can be risky but also shows growth ambition.
Quick Tip: Remember that profitability ratios are meaningless without comparison - always compare to previous years or industry averages to spot trends and performance relative to competitors.
Efficiency ratios measure how well a business manages its resources. Inventory turnover shows how many times stock is sold per year (cost of goods sold ÷ inventory held). Payables days and receivables days reveal how long the company takes to pay suppliers and collect from customers respectively.
Liquidity ratios assess whether a business can meet short-term obligations. The current ratio (current assets ÷ current liabilities) should ideally fall between 1.5:1 and 2:1 - this shows you can cover debts without being too cash-heavy.