LIQUIDITY RATIOS

Current Ratio The current ratio is a general indicator of the business's ability to meet its short-term financial commitments. This ratio assumes that all current assets, if required, can be converted to cash immediately in order to meet all current liabilities immediately. Many texts recommend that the current ratio should be at least 2:1, that is current assets should be at least twice the value of current liabilities. Presumably, this is to allow a safety margin, as current assets do not usually achieve their full value if they have to be converted to cash in a hurry. Nowadays, it is very difficult to prescribe a desirable current ratio. Technological advances in stock and inventory management have reduced the value of stocks on many balance sheets. Aggressive financial management strategies by large companies have resulted in higher levels of trade creditors, and a tightening grip on trade debtors. It is therefore important to look at the trend for an individual business, and to compare businesses within the same industry segment. Acid Test / Quick Ratio Quick ratio is the current ratio modified to provide a more prudent measure of short-term liquidity. The acid test ratio deducts stock and work-in-progress from current assets. This approach is more cautious as it recognizes that stock is not always readily converted into cash at full value

DEBT MANAGEMENT
Gearing Ratio The gearing ratio measures the percentage of capital employed that is financed by debt and long term finance. The higher the gearing, the higher the dependence on borrowings and long term financing. The lower the gearing ratio, the higher the dependence on equity financing. Traditionally, the higher the level of gearing, the higher the level of financial risk due to the increased volatility of profits. Financial managers face a difficult dilemma. Most businesses require long term debt in order to finance growth, as equity financing is rarely sufficient. On the other hand, the introduction of debt and gearing increases financial risk. But the company dependant on equity financing alone is unable to sustain growth. How much debt can a company take on before the benefits of growth are overtaken by the disadvantages of financial risk

Interest Cover While the gearing ratio measures the relative level of debt and long term finance, the interest cover ratio measures the cost of long term debt relative to earnings. In this way the interest cover ratio attempts to measure whether or not the company can afford the level of gearing

PROFITIBILITY RATIOS
Return on Total Assets (ROTA) - Explanation Return on total assets is a measure of profit in relation to the total assets invested in the business, and ignores the way in which such assets have been financed. The total assets of the business provide one way of measuring the size of the business. This ratio measures the ability of general management to utilize the total assets of the business in order to generate profits Net Profit Margin The net profit margin, sometimes known as the trading profit margin measures trading profit relative to sales revenue. Thus a trading profit margin of 10% means that every 1.00 of sales revenue generates .10 (10p) in profit before interest and taxes. Some industries tend to have relatively low margins, which are compensated for by high volumes. Conversely, high margin industries may be low volume. Higher than average net profit margins for the industry may be an indicator or good management Price earning ratio The price earnings ratio compares the benefits derived from owning a share with the cost of purchasing such a share. It provides a clear indication of the value placed by the capital market on those earnings and what it is prepared to pay for participation. It reflects the capital market assessment of both the amount and the risk of these earnings, albeit subject to overall market and economic considerations. Return on Equity Return on Equity (ROE) is an indicator of company's profitability by measuring how much profit the company generates with the money invested by common stock owners. It is also known as Return on Net Worth.

ASSET MANAGEMENT RATIOS

Inventory Turnover
The inventory/stock turnover period indicates the average number of days that inventory/stock is held for. A change in the inventory/stock turnover period can be a useful indicator of how well a company is doing. A lengthening in the inventory/stock turnover period may indicate a slowing down of trading or an unnecessary build up of inventory/stock Fixed Assets Turnover Fixed asset turnover ratio compares the sales revenue a company to its fixed assets. This ratio tells us how effectively and efficiently a company is using its fixed assets to generate revenues. This ratio indicates the productivity of fixed assets in generating revenues. If a company has a high fixed asset turnover ratio, it shows that the company is efficient at managing its fixed assets. Fixed assets are important because they usually represent the largest component of total assets. Total Assets Turnover Asset turnover (total asset turnover) is a financial ratio that measures the efficiency of a company's use of its assets to product sales. It is a measure of how efficiently management is using the assets at its disposal to promote sales. The ratio helps to measure the productivity of a company's assets.

LEVERAGE RATIOS
Degree of Financial Leverage The degree of financial leverage (DFL) is the leverage ratio that sums up the effect of an amount of financial leverage on the earning per share of a company. The degree of financial leverage or DFL makes use of fixed cost to provide finance to the firm and also includes the expenses before interest and taxes. If the Degree of Financial Leverage is high, the Earnings Per Share or EPS would be more unpredictable while all other factors would remain the same. The degree of financial leverage or DFL helps in calculating the comparative change in net income caused by a change in the capital structure of business. This ratio would help in determining the fate of net income of the business. This ratio also helps in determining the suitable financial leverage which is to be used to achieve the business goal. The higher the leverage of the company, the more risk it has, and a business should try and balance it as leverage is similar to having a debt. The degree of financial leverage is useful for figuring out the fate of net income in the future, which is based on the changes that take place in the interest rates, taxes, operating expenses and other financial factors. Debts added to a business would provide an interest expense to the company which is a fixed cost, and this is when the companys business begins to turn to

provide profit. It is important to balance the financial leverage according to the operating costs of the company as it would minimize the level of risks involved.

Degree of Operating Leverage

The Degree of Operating Leverage (DOL) is the leverage ratio that sums up the effect of an amount of operating leverage on the companys earnings before interests and taxes (EBIT). Operating Leverage takes into account the proportion of fixed costs to variable costs in the operations of a business. If the degree of operating leverage is high, it means that the earnings before interest and taxes would be unpredictable for the company, even if all the other factors remain the same. The Degree of Operating Leverage Ratio helps a company in understanding the effects of operating leverage on the companys probable earnings. It is also important in determining a suitable level of operating leverage which can be used in order to get the most out of the companys Earnings before interest and taxes or EBIT. If the operating leverage is high, then a smallest percentage change in sales can increase the net operating income. The net operating income is the amount of income that is left after payments of fixed cost are made, regardless of how much sales has been made. Since the Degree of Operating Leverage or DOL helps in determining how the change in sales volume would affect the profits of the company, it is important to ascertain the value of degree of operating leverage in order to minimize the losses to the company. A business would benefit if the can estimate the Degree of Operating Leverage or DOL. The impact of the leverage on the percentage of sales can be quite striking if not taken seriously; therefore it is really important to minimize these risks of the business. If you get a higher degree of operating leverage or DOL then you should try and balance the operating leverage to balance with the financial leverage in order to provide with profits to the company. A companys balance Degree of Operating Leverage can provide the financial leverage is an important factor contributing to business profits. Even a small percentage of increase in sales can help in having a greater proportion of profits in the company, so it is really important to maintain a balance between both financial leverage and operating leverage to yield maximum benefits.