All Collections
Financial Ratios Explained
Financial Ratios Explained

Explaining what the financial ratio means on the factsheet

Shaun avatar
Written by Shaun
Updated over a week ago

Revenue Growth

The rate of change in revenue compared to the previous year’s revenue performance

Gross Margin

Is a percentage based on a business’s total revenue minus their cost of goods sold, all divided by the total sales revenue. The higher the ratio the better.

Net Margin

Is a percentage of the remaining revenue after subtracting all the operational expenses of the business (net profit) over total revenue. The operational costs can include returns , taxes and preferred stock dividends. The higher the ratio the better.

Current ratio

Is also known as liquidity ratio and it highlights the business’s ability to pay their short term and long term liabilities. A current ratio that is under 100% means that it has more liabilities than assets. This means that the business may have problems paying off its obligations. A current ratio above 100% means that they have a better capacity to pay their obligations as their assets are more than their liabilities.  

Quick Ratio

Also known as acid-test ratio measures the business’s ability to meet their short term liabilities

What does it mean? 

It is similar to the current ratio where the higher the ratio the better the business’s ability to pay their liabilities in the short term. If the quick ratio is low (ie under 100%) it shows that the business may be paying their liabilities too quickly, struggling to main or grow sales or are collecting receivables (payment from customers for the business’s goods and services) too slowly.

Leverage Ratio

Is calculated by taking the total liabilities over the total equity (value of shares issued by the company) of the business. 

A high leverage ratio means that business is aggressively financing growth through acquiring a lot of debt and this could be mean that there is a high chance of default as the returns expenses to service the debt may be too high for the business to pay. Businesses that operate in industries that require higher capital expenditure such as large scale manufacturing and utility industries may need to take on more debt, meaning they have a higher leverage ratio than other industries. To compare the performance of an individual businesses using this method, it is recommended that you compare other businesses in the same industry to see what is ‘normal’ for that industry.

Gearing Ratio

Is the amount of debt of the business compared to the total equity of the business

What does this mean?

Please see leverage ratio explanation. 

Pre-tax returns coverage

This is used to find out how easily a business can service their returns based on their outstanding debt. It is calculated by the following formula:

Earnings before returns and taxes (EBIT)

The lower the ratio is, the more debt expenses are burdening the company. A ratio of 1.5% or lower will mean that the business may have difficulty to service their debt commitments and a ratio below 1 indicates that the business may not have enough revenue to service their returns expenses. 


Return (before tax) on the net worth

This is calculated with the following formula:

This is the earnings/returns of a shareholder for each dollar they have invested, this is before taxes are deducted. 

Receivables Turnover

This ratio indicated the business’s ability to recover their receivables on the credit that they have extended to their customers- it allows you to measure how efficiently the business uses its assets.

A high ratio implies that 

  • The company may operate on a cash basis 

  • They are efficient in receiving their receivables 

  • Their customers are mainly able to pay off their debts quickly

  • The business maybe conservative in extending credit (maybe discouraging business however)

A low ratio implies that:

  • They have inefficient collecting processes

  • A poor credit policy, or none at all

  • Customers who are not repaying on time or at all, or their customers maybe in financial hardship

Payables Turnover

This measures the rate that a business repays their suppliers

If the ratio is decreasing over time, it means that the business is paying their suppliers slower than before and vice versa if the ratio is increasing, ie the business is paying their suppliers quicker than before.

Inventory Turnover

The amount of times inventory is sold or used over a year

A low ratio may mean that the business is overstocking or there are deficiencies in the production line, however a business may have a lower ratio that number because they are forecasting higher stock costs or shortages in the future.

A high ratio means that there are insufficient inventory levels, meaning that they are at risk of being out of stock, effecting business. 

Total Asset Turnover

Indicates a business’s ability to generate sales from their assets.

A high ratio shows that the business is efficiently using their assets to generate sales and vice versa. 

Did this answer your question?