Profitability Ratios
| Ratio | Formula | Good Range | Tells You |
|---|---|---|---|
| Gross Margin | Gross Profit / Revenue | 30-80%+ | Pricing power and COGS efficiency |
| Operating Margin | Operating Income / Revenue | 10-25%+ | Core business profitability |
| Net Margin | Net Income / Revenue | 5-20%+ | Bottom-line profitability |
| Return on Equity (ROE) | Net Income / Shareholder Equity | 15%+ | Efficiency of shareholder capital use |
| Return on Assets (ROA) | Net Income / Total Assets | 5%+ | Asset utilization efficiency |
| Return on Invested Capital (ROIC) | NOPAT / Invested Capital | 10%+ | True economic profitability |
Liquidity Ratios
| Ratio | Formula | Good Range | Tells You |
|---|---|---|---|
| Current Ratio | Current Assets / Current Liabilities | 1.5-3.0x | Short-term financial health |
| Quick Ratio | (CA - Inventory) / Current Liabilities | 1.0x+ | Liquid asset coverage |
| Cash Ratio | Cash / Current Liabilities | 0.5x+ | Most conservative liquidity test |
| Free Cash Flow | Operating CF - CapEx | Positive | True cash generation after reinvestment |
| FCF Yield | FCF / Market Cap | 4%+ | Cash return relative to price paid |
Leverage & Debt Ratios
| Ratio | Formula | Caution Zone | Tells You |
|---|---|---|---|
| Debt/Equity | Total Debt / Shareholder Equity | >2.0x | Financial leverage level |
| Net Debt/EBITDA | Net Debt / EBITDA | >4.0x | Debt payback timeline |
| Interest Coverage | EBIT / Interest Expense | <3.0x = risky | Ability to service debt |
| Debt/EBITDA | Total Debt / EBITDA | >5.0x = high risk | Absolute debt burden |
Key Red Flags in Financial Ratios
- Revenue growing faster than receivables is healthy; receivables growing faster than revenue = revenue inflation risk
- Gross margin compression while revenue grows = pricing power loss or cost problem
- High ROE with high debt = leverage-inflated ROE, not real value creation (DuPont analysis)
- Free cash flow consistently below net income = aggressive revenue recognition
- Increasing days sales outstanding (DSO) = customers not paying / collection issues
- Goodwill > 50% of total assets = acquisition-heavy strategy with write-down risk