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Financial Statement Analysis: Liquidity, Profitability, and Leverage Ratios

Definitions, formulas, and interpretation of liquidity, profitability, and leverage ratios used in financial statement analysis.

9 cards· by GuruOwl

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  1. 01
    The current ratio is calculated as current assets divided by current liabilities.
    A value above 1.5–2.0 is generally considered comfortable, though industry norms vary.
    Flashify::FinancialRatios::Liquidity
  2. 02
    The quick ratio (acid-test) is calculated as (current assets minus inventory) divided by current liabilities.
    This is a stricter liquidity test because inventory may not be easily converted to cash.
    Flashify::FinancialRatios::Liquidity
  3. 03
    The cash conversion cycle formula is days inventory outstanding + days sales outstanding - days payables outstanding.
    This metric quantifies how efficiently a company manages its working capital.
    Flashify::FinancialRatios::Efficiency
  4. 04
    The gross profit margin is calculated as (revenue minus COGS) divided by revenue.
    It reflects a company's pricing power and production efficiency.
    Flashify::FinancialRatios::Profitability
  5. 05
    Return on Assets (ROA) is calculated as net income divided by average total assets.
    It indicates how efficiently management uses assets to produce profit.
    Flashify::FinancialRatios::Profitability
  6. 06
    According to DuPont analysis, ROE is decomposed into profit margin × asset turnover × equity multiplier.
    This decomposition helps identify which driver is responsible for changes in return on equity.
    Flashify::FinancialRatios::Profitability
  7. 07
    The interest-coverage ratio (times interest earned) is calculated as EBIT divided by interest expense.
    Values below 1.5–2.0 typically signal potential financial distress.
    Flashify::FinancialRatios::Solvency
  8. 08
    How does high leverage affect Return on Equity (ROE) and risk?
    High leverage amplifies ROE during profitable periods but increases bankruptcy risk.
    The equity multiplier (Total Assets / Equity) is the component of DuPont analysis that captures this effect.
    Flashify::FinancialRatios::Solvency
  9. 09
    To ensure valid comparisons, analysts must adjust ratios for off-balance-sheet items, non-recurring charges, and accounting choices like depreciation methods.
    Adjustments are necessary to normalize data across different firms or historical periods.
    Flashify::FinancialRatios::Analysis