The Ultimate Guide to Fundamental Analysis Ratios: Formulas, Examples, and How to Use Them

Introduction

Fundamental analysis is a method used by investors to evaluate the intrinsic value of a company and make informed investment decisions. It involves analyzing various financial ratios to assess a company’s financial health, profitability, efficiency, and market value. Here are some common groups of ratios used in fundamental analysis, along with their formulas and examples:

1. Liquidity Ratios:

Current Ratio: Measures a company’s ability to cover short-term liabilities with its short-term assets.

• Formula: Current Ratio = Current Assets / Current Liabilities
• Example: If a company has current assets of $500,000 and current liabilities of $250,000, the current ratio would be 2 ($500,000 / $250,000).

Quick Ratio: Provides a more stringent measure of a company’s ability to meet short-term obligations, excluding inventory from current assets..

• Formula: Quick Ratio = (Current Assets – Inventory) / Current Liabilities
• Example: If a company has current assets of $500,000, inventory of $100,000, and current liabilities of $250,000, the quick ratio would be 1.6 (($500,000 – $100,000) / $250,000).

2. Profitability Ratios:

Gross Profit Margin: Indicates the percentage of revenue that remains after deducting the cost of goods sold.

• Formula: Gross Profit Margin = (Gross Profit / Revenue) x 100
• Example: If a company has a gross profit of $200,000 and revenue of $500,000, the gross profit margin would be 40% (($200,000 / $500,000) x 100).

Net Profit Margin: Measures the percentage of revenue that remains as net profit after deducting all expenses, including taxes and interest.

• Formula: Net Profit Margin = (Net Profit / Revenue) x 100

• Example: If a company has a net profit of $50,000 and revenue of $200,000, the net profit margin would be 25% (($50,000 / $200,000) x 100).

3. Efficiency Ratios:

Inventory Turnover: Measures how quickly a company sells its inventory within a specific period.

• Formula: Inventory Turnover = Cost of Goods Sold / Average Inventory
• Example: If a company has cost of goods sold of $500,000 and average inventory of $100,000, the inventory turnover would be 5 ($500,000 / $100,000).

Accounts Receivable Turnover: Evaluates how efficiently a company collects payments from its customers.

• Formula: Accounts Receivable Turnover = Net Credit Sales / Average Accounts Receivable
• Example: If a company has net credit sales of $1,000,000 and average accounts receivable of $200,000, the accounts receivable turnover would be 5 ($1,000,000 / $200,000).

4. Debt Ratios:

Debt-to-Equity Ratio: Compares a company’s total debt to its shareholders’ equity, indicating its financial leverage.

• Formula: Debt-to-Equity Ratio = Total Debt / Shareholders’ Equity
• Example: If a company has total debt of $1,000,000 and shareholders’ equity of $500,000, the debt-to-equity ratio would be 2 ($1,000,000 / $500,000).

Interest Coverage Ratio: Measures a company’s ability to cover its interest expenses with its earnings before interest and taxes (EBIT).

• Formula: Interest Coverage Ratio = Earnings Before Interest and Taxes (EBIT) / Interest Expense
• Example: If a company has EBIT of $200,000 and interest expense of $50,000, the interest coverage ratio would be 4 ($200,000 / $50,000).

5. Market Value Ratios:

Price-to-Earnings (P/E) Ratio: Compares a company’s stock price to its earnings per share, reflecting market expectations.

• Formula: Price-to-Earnings (P/E) Ratio = Market Price per Share / Earnings per Share
• Example: If a company’s stock has a market price of $50 per share and earnings per share of $5, the P/E ratio would be 10 ($50 / $5).

Price-to-Sales (P/S) Ratio: Compares a company’s stock price to its revenue per share, providing insight into its market valuation.

• Formula: Price-to-Sales (P/S) Ratio = Market Price per Share / Revenue per Share
• Example: If a company’s stock has a market price of $100 per share and revenue per share of $20, the P/S ratio would be 5 ($100 / $20).

6. Growth Ratios:

Earnings Per Share (EPS) Growth Rate: Calculates the percentage increase in a company’s earnings per share over a specific period.

Formula: EPS Growth Rate = ((Current Year EPS – Previous Year EPS) / Previous Year EPS) x 100

Example: Let’s assume a company’s EPS was $2.00 in the previous year and $2.50 in the current year. To calculate the EPS growth rate:

Sales Growth Rate: Measures the percentage increase in a company’s revenue over a specific period.

Formula: Sales Growth Rate = ((Current Year Sales – Previous Year Sales) / Previous Year Sales) x 100

Example: Let’s assume a company had sales of $1,000,000 in the previous year and $1,200,000 in the current year. To calculate the sales growth rate:

Sales Growth Rate = (($1,200,000 – $1,000,000) / $1,000,000) x 100

= ($200,000 / $1,000,000) x 100

= 0.20 x 100 = 20%

Conclusion

These are just a few examples of the many ratios used in fundamental analysis. By calculating and analyzing these ratios, investors can gain insights into a company’s financial health, profitability, efficiency, and market valuation, allowing them to make more informed investment decisions.

It’s important to compare these ratios to industry benchmarks or historical data to get a better understanding of a company’s performance.