15 Financial Ratios Explained: Formulas, Examples & Exercises

Can a company report a profit and still struggle to pay its bills? Can two companies earn the same profit but have completely different financial health?

The answers often lie in financial ratio analysis.

In this Fincary Accounting Foundations lesson, we explain 15 important financial ratios using simple language, practical examples and a fictional business called VibeCart. Whether you are an accounting student, business owner, entrepreneur or beginner in finance, this guide will help you understand what the numbers are actually telling you.

What Are Financial Ratios?

Financial ratios are calculations that help us understand a business by comparing figures from its Profit and Loss Statement, Balance Sheet and Cash Flow Statement.

Instead of looking at hundreds of numbers individually, ratios help answer questions such as:

• Can the business pay its short-term bills?
• How much profit does it make from its sales?
• Is the business borrowing too much?
• Can its earnings cover interest payments?
• How quickly does it collect money from customers?
• Is the company generating enough cash?
• How much are investors paying for its earnings?

Every ratio answers a different question. Understanding them together provides a clearer picture of financial health.

15 Important Financial Ratios Explained

1. Current Ratio — Can the Business Pay Its Short-Term Bills?

Formula: Current Assets / Current Liabilities

This ratio compares resources expected to turn into cash or be used within the short term against short-term obligations. A ratio of 2 means the business has ₹2 of current assets for every ₹1 of current liabilities.

2. Quick Ratio — Can It Pay Without Selling Inventory?

Formula: (Current Assets - Inventory - Prepaid Expenses) / Current Liabilities

The quick ratio provides a stricter liquidity check by excluding inventory and prepaid expenses. It helps assess whether a business can meet short-term obligations without relying on selling its stock.

3. Gross Profit Margin — How Much Is Left After Direct Costs?

Formula: Gross Profit / Revenue × 100

If the gross profit margin is 40%, the company retains ₹40 from every ₹100 of revenue after deducting the cost of goods sold, before other operating costs and expenses.

4. Net Profit Margin — How Much Profit Does the Business Actually Keep?

Formula: Net Profit / Revenue × 100

A 10% net profit margin means the business earns ₹10 in net profit from every ₹100 of revenue.

5. Return on Equity (ROE) — How Effectively Is Shareholders' Money Used?

Formula: Net Profit / Average Shareholders' Equity × 100

ROE measures the profit generated relative to shareholders' equity. Higher returns may indicate effective use of capital, but heavy borrowing can also influence ROE.

6. Return on Assets (ROA) — How Productively Are Assets Used?

ROA measures how effectively a business uses its assets to generate returns. It helps compare the performance of businesses with different levels of investment in assets.

7. Debt-to-Equity Ratio — How Much Does the Business Rely on Borrowing?

Formula: Total Debt / Shareholders' Equity

This ratio compares borrowings with shareholders' funds. Higher debt may increase financial risk, especially when earnings or cash flows decline.

8. Interest Coverage Ratio — How Many Times Can Earnings Cover Interest?

Formula: EBIT / Interest Expense

If the interest coverage ratio is 4, earnings before interest and tax are four times the interest expense. It indicates the earnings cushion available to cover interest costs, but does not guarantee sufficient cash or loan principal repayment capacity.

9. Inventory Turnover Ratio — How Quickly Is Stock Sold?

This ratio measures how often inventory is sold and replaced during a period. It helps businesses identify slow-moving stock and evaluate inventory efficiency.

10. Receivables Days — How Long Do Customers Take to Pay?

Receivables days estimates the average time taken to collect money from customers. Longer collection periods can put pressure on working capital and cash flow.

11. Payables Days — How Long Does the Business Take to Pay Suppliers?

Payables days estimates the average payment period for suppliers. It helps understand supplier credit and working capital management.

12. Asset Turnover Ratio — How Much Revenue Do Assets Generate?

This ratio compares revenue with assets employed in the business. It indicates how efficiently assets are being used to generate sales.

13. Operating Cash Flow Ratio — Can Business Cash Flow Cover Short-Term Obligations?

Formula: Operating Cash Flow / Current Liabilities

This ratio compares cash generated from regular business activities with current liabilities. It adds an important cash-based perspective to liquidity analysis.

14. Earnings Per Share (EPS) — How Much Profit Is Earned Per Share?

EPS expresses earnings attributable to ordinary shareholders on a per-share basis. It is commonly used in analysing listed companies.

15. Price-to-Earnings (P/E) Ratio — How Much Are Investors Paying for Earnings?

Formula: Market Price Per Share / Earnings Per Share

A P/E ratio of 15 means investors are paying ₹15 for every ₹1 of annual earnings per share. A higher or lower P/E is not automatically good or bad; it must be interpreted in context.

Learn with a Complete VibeCart Example

Throughout this lesson, we use VibeCart, a fictional retail business, to demonstrate ratio calculations using connected financial statements.

VibeCart reports ₹120 lakh in revenue and ₹12 lakh in profit after tax. We use its financial information to explain how different ratios reveal different aspects of the same business.

You will also learn why a profitable company may still face liquidity problems, why a high return on equity can sometimes be misleading, and why financial ratios should never be interpreted in isolation.

Download the Free Financial Ratios Study Guide and Exercise Workbook

Continue learning beyond the video with Fincary's detailed PDF study material.

• Step-by-step explanations of all 15 financial ratios
• Formulas and worked VibeCart calculations
• Simple interpretations and practical limitations
• Independent exercises using BrightBasket, another fictional business
• Practice questions and worked solutions

Download the Free Financial Ratios Study Guide and Exercise Workbook

Frequently Asked Questions

Which financial ratio is the most important?

No single ratio is the most important for every business. Liquidity ratios measure short-term financial strength, profitability ratios measure earnings, and debt ratios help evaluate borrowing risk. They should be analysed together.

Is a higher financial ratio always better?

No. A high current ratio may indicate unused resources, a high ROE may be influenced by borrowing, and a high P/E may reflect market expectations rather than proven performance.

Can beginners learn financial ratio analysis?

Yes. Start by understanding the question each ratio answers, then learn the formula, calculate a simple example and interpret the result.

Are financial ratios useful for small businesses?

Yes. Ratios can help small businesses monitor profitability, customer collections, inventory, debt and cash flow, even when the business is not listed on a stock exchange.

Continue Learning with Fincary

This lesson is part of Fincary's Accounting Foundations series. Explore our other lessons on debit and credit, journal entries, accounting principles, trial balances and preparation of financial statements.

Fincary — Finance, minus the repetition.

Educational disclaimer: All example companies and figures are fictional. This content is intended for education and does not constitute investment advice.