Financial ratio calculator

Which financial ratios does this calculator work out?

Ratios fall into four families, and an analysis usually needs a few from each. The default figures belong to one company: revenue $2,400,000, cost of sales $1,560,000, PBIT $360,000, finance cost $45,000, current assets $620,000 (inventory $240,000 and trade receivables $300,000 among them), current liabilities $400,000 including trade payables of $260,000, debt $600,000 and equity $1,400,000.

How do you calculate ROCE, and why is it margin times asset turnover?

Return on capital employed measures the operating profit earned on the long-term funds invested in the business. This calculator uses ROCE = PBIT / capital employed, with capital employed = total equity + interest-bearing debt, both at the year end. For the default company: 360,000 / (1,400,000 + 600,000) = 360,000 / 2,000,000 = 18.0%.

ROCE splits into two ratios that explain where it comes from:

1. Operating margin = 360,000 / 2,400,000 = 15.0%: how much of each sale is operating profit.
2. Asset turnover = 2,400,000 / 2,000,000 = 1.20 times: how much revenue each unit of capital generates.
3. 15.0% x 1.20 = 18.0%, the ROCE again.

So when ROCE falls, the question is whether margins weakened or the capital base grew faster than sales, for instance after a large investment late in the year that has not yet produced revenue. PBIT is used rather than profit after interest because capital employed includes the lenders' money as well as the shareholders'.

How do you calculate the current ratio and the quick ratio?

Both compare short-term assets with short-term obligations. Current ratio = current assets / current liabilities = 620,000 / 400,000 = 1.55:1 for the default company. The quick ratio, or acid test, leaves out inventory because it is the hardest current asset to turn into cash: (620,000 - 240,000) / 400,000 = 380,000 / 400,000 = 0.95:1.

There is no single correct level for either. A business that sells for cash but buys on credit has few receivables and large trade payables, so a quick ratio below one can be a normal result of how it trades, while a business with slow-moving stock may need more cover. The useful comparisons are with the same company's earlier years and with businesses in the same line of trade. A very high current ratio is not automatically good news either: it can mean cash or inventory sitting idle.

How is gearing calculated: debt to equity or debt to capital?

Gearing measures how much of the business is financed by borrowing, and two definitions are in common use. The calculator shows both, because a question or a set of notes may use either:

• Debt / equity = 600,000 / 1,400,000 = 42.9% for the default company.
• Debt / (debt + equity) = 600,000 / 2,000,000 = 30.0%.

The gap widens as borrowing grows. A European company in euros with debt of €3,000,000 and equity of €2,000,000 has gearing of 150% on the first basis but 60% on the second. Always state which one you used, and never compare a debt-to-equity figure with a debt-to-capital figure. Some definitions also count preference shares or lease liabilities as debt; the calculator uses whatever figure you enter as debt.

Interest cover, PBIT / finance cost, looks at the same risk from the income statement: 360,000 / 45,000 = 8.00 times, so operating profit could fall by seven eighths before it failed to cover the interest.

How do you calculate inventory, receivable and payable days?

The efficiency ratios turn balance sheet amounts into days of trading. Inventory and payables are measured against cost of sales, because both are carried at cost; receivables are measured against revenue, because they include the profit margin:

1. Inventory days = 240,000 / 1,560,000 x 365 = 56.2 days.
2. Receivable days = 300,000 / 2,400,000 x 365 = 45.6 days.
3. Payable days = 260,000 / 1,560,000 x 365 = 60.8 days.

Strictly, payable days should use credit purchases, but accounts rarely show them, so cost of sales is the usual stand-in and is what the calculator uses. Receivable days likewise assume all sales are on credit. If a question gives credit sales or purchases, use those figures in the revenue or cost of sales fields for that ratio. Combining the three into a cash conversion cycle is the job of the working capital calculator.

Year-end or average balances, 365 or 360 days?

Textbooks and lenders differ, and the choice changes the answer. A UK wholesaler with revenue of £850,000 and cost of sales of £510,000 shows how much:

When balances are growing, year-end figures give longer days than averages. Exam questions usually supply only one balance sheet date, so year-end figures are the default here; switch to averages when you have both. The day count matters less: the default receivables come to 45.6 days on a 365-day year and 45.0 on a 360-day year. Whatever you choose, use it for every year you compare.

How do you calculate financial ratios in Excel?

Lay the accounts out in one column and write each ratio as a cell formula, so a second year can be added beside it and the ratios copied across. With revenue in B2, cost of sales in B3, PBIT in B4, finance cost in B5, current assets in B6, inventory in B7, receivables in B8, current liabilities in B9, payables in B10, debt in B11 and equity in B12:

• Current ratio =B6/B9; quick ratio =(B6-B7)/B9.
• Gross margin =(B2-B3)/B2; operating margin =B4/B2; ROCE =B4/(B11+B12), formatted as percentages.
• Gearing =B11/B12 or =B11/(B11+B12); interest cover =B4/B5.
• Inventory days =B7/B3*365; receivable days =B8/B2*365; payable days =B10/B3*365.

Wrap a ratio in =IFERROR(...,"n/a") so a zero denominator shows text rather than an error. Google Sheets accepts the same formulas.

How do you interpret ratios in an exam answer?

A ratio on its own says little; marks come from comparison and explanation. Compare each ratio with the prior year or with another company, say whether it improved or worsened, and give a reason grounded in the scenario: a price rise, a new contract, a change in credit terms, an asset revaluation or a loan taken out near the year end. Link ratios together where you can. A falling gross margin alongside rising revenue may point to discounting to win sales; rising receivable days alongside a falling quick ratio may point to cash pressure.

Watch for distortions: a revaluation raises equity and lowers ROCE without any change in trading, and a year-end loan raises gearing for a business that has not yet spent the money. Finish with the limits of the analysis, such as different accounting policies between companies or a single balance sheet date that may not be typical.

Common ratio mistakes

• Mixing definitions. Comparing debt-to-equity gearing with debt-to-capital gearing, or year-end days with average days, makes any comparison meaningless.
• Using profit after interest for ROCE. Capital employed includes debt, so the return must be before the interest paid on it.
• Putting receivables over cost of sales. Receivables carry the profit margin, so they go over revenue.
• Leaving out debt from capital employed. That overstates ROCE for any company that borrows.
• Rounding the parts before multiplying. Keep margin and turnover unrounded when checking that they reproduce ROCE.
• Calculating without commenting. In an exam a table of ratios earns limited credit until each one is explained.

What the ratio calculator leaves out, and a glossary

The calculator covers single-year ratios from figures you enter. It does not compare two years side by side, adjust for leases, revaluations or one-off items, or compute investor ratios such as earnings per share, dividend cover or the price to earnings ratio. It holds no industry averages, so comparisons are yours to make. For valuation multiples, see the P/E ratio calculator.

PBIT: profit before interest and tax, or operating profit. Capital employed: here, total equity plus interest-bearing debt. ROCE: PBIT as a percentage of capital employed. Gearing: the share of finance that comes from borrowing. Interest cover: how many times PBIT covers the finance cost. Quick ratio: current assets less inventory, over current liabilities. Asset turnover: revenue per unit of capital employed or total assets. Receivable days: the average time customers take to pay.

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