Understanding Financial Ratios

Reading Time: 2 minutes

Financial Ratios can be said is one the most loved questions in professional qualification examinations like the CPA / CMA. Students often can get overwhelmed trying to remember every single ratio in their head. Let’s see how to easily remember these ratios?

Take for example the following ratios: 

Times Interest Earned Ratio

The ratio name gives away the formula. It has both interest and earnings in its name so both are items in the P & L statement. Basically, the formula wants you to calculate the number of times I can cover my interest cost with the earnings in the period. Example: If the company’s EBIT(Earnings before Interest and Tax) is $1000 and the interest cost is $100. Times Interest Earned is 10. It’s a ratio generally used by creditors to check the earnings potential, solvency, and ability of the company to repay its debts from its earnings. 

Debt to Equity Ratio

Both are balance sheet items – all you have to do is divide the company’s debt to its equity. Higher Debt to Equity ratio means the company is leveraged to a higher degree. 

Current Ratio

The name current should ring a bell that it is a point in time ratio so you should scan your eyes to the balance sheet for current assets and divide it by current liabilities.

Cash Flow Ratio

The name cash flow indicates that you have to look for it in the cash flow statement. As an analyst you would be interested in knowing the cash flow from the normal course of business – so you take the cash flow from operating activities(available in cash flow statement) and divide it with the current liabilities(balance sheet) to arrive at this ratio. A higher ratio indicates a firm’s ability to meet the current liabilities with cash generated from the core business. 

Price Earnings Ratio

As the name says, it’s the current market price per share divided by earnings (expressed as earnings per share for current or expected future earnings). The PE ratio says how much price is the market willing to pay for $1 of earnings. A forward PE ratio of 20 means the market is willing to pay $20(to buy a single share of the company) for each $1 in expected future earnings. 

To summarize, it’s important to read the ratio properly and most of the time, it will  give away the contents of the formula as can be seen from the examples above.

Leave a Comment

Your email address will not be published. Required fields are marked *

Featured Blogs

Leave a Comment

Your email address will not be published. Required fields are marked *

Featured Post

FinTech Space: 5 Indian Women Holding the Reins

FinTech Space: 5...

Technology can transform the world for good. Women across continents...

18 Jan 22

Read more

4 Steps to becoming a Data-driven HR and People Manager

4 Steps to...

A recent study by Gartner found that over 70% of...

18 Jan 22

Read more

UNDERSTANDING or MEMORIZING! Which Code helps Crack the CFA Exam?

UNDERSTANDING or MEMORIZING!...

Obtaining the CFA charter is something like hiking one of...

17 Jan 22

Read more

Everything you need to know about the CPA exam

Everything you need...

Certified public accountants are one of the most in-demand professionals...

15 Jan 22

Read more

How to apply for a CFA Course in India? CFA India,CFA course in India, Cfa college in India, CFA institute in india, Best CFA coaching in India, CFA coaching in India, CFA 1st level exam

How to apply...

CFA® (Chartered Financial Analyst®) is a post-graduate professional designation given...

11 Jan 22

Read more

Ace your CMA exams indoors now with remote testing

Ace your CMA...

As accounting professionals, protecting your academic integrity is highly important...

11 Jan 22

Read more

Inclusive CPAs for exclusive business growth

Inclusive CPAs for...

The Tax season will begin soon, with companies looking to...

8 Jan 22

Read more

People Analytics: newage aid to drive employee engagement; XLRI hr courses, hr analytics course xlri, hr analytics certification, pg courses for hr, pg courses for hrm, hr analytics course, hr courses online

People Analytics: Newage...

Employee engagement is definitely one of the most discussed yet...

6 Jan 22

Read more

kaplanOriginal study package a proven guide to CFA career success

Kaplan Original Study...

Titles like CFA might look like an alphabet soup, but...

5 Jan 22

Read more

hallmark tips to a great us cma career in 2022

Hallmark Tips to...

US CMA as a gold standard certification is one of...

3 Jan 22

Read more