Ratio Analysis

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RatioFormulaExplanation
Current RatioCurrent Assets / Current LiabilitiesMeasures a company’s ability to pay short-term obligations with its short-term assets. A ratio above 1 indicates the company has more current assets than current liabilities, implying liquidity.
Quick Ratio(Current Assets – Inventory) / Current LiabilitiesSimilar to the current ratio but excludes inventory, providing a more conservative measure of liquidity. It indicates the company’s ability to meet short-term obligations using its most liquid assets.
Debt-to-Equity RatioTotal Debt / Total EquityIndicates the proportion of a company’s financing provided by creditors versus shareholders. A higher ratio suggests higher financial risk, as it indicates higher reliance on debt financing.
Return on Equity (ROE)Net Income / Shareholders’ EquityMeasures a company’s profitability relative to shareholders’ equity. It indicates how effectively the company is using equity to generate profits. Higher ROE implies better profitability and efficient use of shareholders’ investments.
Return on Assets (ROA)Net Income / Total AssetsMeasures a company’s profitability relative to its total assets. It indicates how effectively the company is using its assets to generate profits. Higher ROA implies more efficient asset utilization and better profitability.
Gross Profit Margin(Gross Profit / Revenue) x 100Measures the percentage of revenue that exceeds the cost of goods sold. It indicates the efficiency of the company’s production or sales process in generating profits. Higher gross profit margin suggests better efficiency in controlling production costs.
Operating Profit Margin(Operating Income / Revenue) x 100Measures the percentage of revenue that represents operating income after deducting operating expenses. It indicates the company’s profitability from core business operations. Higher operating profit margin indicates better efficiency in managing operating expenses.
Net Profit Margin(Net Income / Revenue) x 100Measures the percentage of revenue that represents net income after deducting all expenses, including taxes and interest. It indicates the company’s overall profitability. Higher net profit margin suggests better cost management and operational efficiency.
Earnings per Share (EPS)Net Income / Weighted Average Shares OutstandingRepresents the portion of a company’s profit allocated to each outstanding share of common stock. It indicates the company’s profitability on a per-share basis and is used to assess its financial performance and attractiveness to investors.
Price-to-Earnings (P/E) RatioMarket Price per Share / Earnings per ShareCompares a company’s stock price to its earnings per share. It indicates the market’s expectations for the company’s future earnings growth. Higher P/E ratio may indicate that investors expect higher future earnings growth, while lower P/E ratio may suggest undervaluation.
Dividend YieldDividend per Share / Market Price per ShareRepresents the dividend income earned per share relative to its market price. It indicates the return on investment from dividends. Higher dividend yield may be attractive to income-seeking investors, while lower dividend yield may indicate lower returns from dividends.
Price-to-Book (P/B) RatioMarket Price per Share / Book Value per ShareCompares a company’s market value to its book value, indicating the market’s perception of the company’s value relative to its assets. A ratio above 1 suggests the stock is trading at a premium to its book value, while a ratio below 1 suggests the stock is trading at a discount.
Debt-to-Asset RatioTotal Debt / Total AssetsMeasures the proportion of a company’s assets financed by debt. It indicates the company’s leverage and financial risk. Higher debt-to-asset ratio implies higher financial risk, as it suggests a higher reliance on debt financing to fund operations.
Inventory Turnover RatioCost of Goods Sold / Average InventoryMeasures the efficiency of inventory management by indicating how many times a company’s inventory is sold and replaced over a period. Higher inventory turnover ratio suggests efficient inventory management and faster sales conversion.
Accounts Receivable Turnover RatioNet Credit Sales / Average Accounts ReceivableMeasures how efficiently a company collects payments from customers. Higher accounts receivable turnover ratio indicates better efficiency in collecting receivables and converting them into cash, which improves liquidity and reduces the risk of bad debts.
Return on Investment (ROI)(Net Profit / Cost of Investment) x 100Measures the profitability of an investment relative to its cost. It indicates the return generated from an investment compared to its initial cost. Higher ROI implies better investment performance, while negative ROI indicates loss-making investments.
Asset Turnover RatioRevenue / Total AssetsMeasures how efficiently a company utilizes its assets to generate revenue. Higher asset turnover ratio indicates better efficiency in asset utilization, as it indicates higher revenue generated per dollar of assets.
Price Earnings Growth (PEG) Ratio(P/E Ratio / Earnings Growth Rate)Combines the P/E ratio with the company’s expected earnings growth rate to provide investors with a more comprehensive view of the stock’s valuation relative to its growth prospects. A lower PEG ratio may indicate that the stock is undervalued relative to its earnings growth potential.
Capital Adequacy Ratio (CAR)(Tier 1 Capital + Tier 2 Capital) / Risk-Weighted AssetsMeasures a bank’s financial strength by comparing its capital (both Tier 1 and Tier 2) to its risk-weighted assets. It ensures that banks have enough capital to cover potential losses and meet regulatory requirements, enhancing stability and protecting depositors and creditors.
Treynor Ratio(Portfolio Return – Risk-Free Rate) / BetaThe Treynor Ratio measures the risk-adjusted return of a portfolio per unit of systematic risk, represented by beta. It helps investors assess whether a portfolio’s returns are sufficient given its level of systematic risk, providing a basis for comparing different investment strategies.
Sharpe Ratio(Portfolio Return – Risk-Free Rate) / Portfolio Standard DeviationThe Sharpe Ratio measures the risk-adjusted return of an investment portfolio. It compares the portfolio’s excess return (return above the risk-free rate) to its volatility (standard deviation). A higher Sharpe Ratio indicates better risk-adjusted performance, making it a valuable tool for evaluating investment strategies.
Sortino Ratio(Portfolio Return – Risk-Free Rate) / Downside DeviationThe Sortino Ratio is a measure of risk-adjusted return that focuses on the downside risk, or volatility of negative returns, of an investment portfolio. It considers only the deviation of returns below a specified target or minimum acceptable return, providing a more focused assessment of risk compared to the Sharpe Ratio.
Information Ratio(Portfolio Return – Benchmark Return) / Tracking ErrorThe Information Ratio measures the risk-adjusted excess return of an investment portfolio relative to a chosen benchmark. It compares the portfolio’s excess return to its tracking error, which represents the volatility of the portfolio’s returns relative to the benchmark. A higher Information Ratio indicates better performance relative to the benchmark on a risk-adjusted basis.
GDP Deflator(Nominal GDP / Real GDP) x 100The GDP Deflator is a measure of inflation or deflation in an economy. It compares the current prices of all new, domestically produced final goods and services included in GDP to the prices of the same goods and services in a base year. It reflects the overall price level changes in the economy and is often used as an indicator of inflationary pressure or changes in the purchasing power of money.
Ratio AnalysisVarious ratios calculated from financial dataRatio Analysis is a financial analysis technique used to evaluate a company’s financial performance by comparing different financial metrics and ratios. It involves analyzing relationships between various financial variables such as liquidity, profitability, solvency, and efficiency to assess the company’s financial health, identify trends, strengths, weaknesses, and make informed decisions about investment or lending. Ratio analysis helps stakeholders understand the company’s operational efficiency, profitability, risk management, and overall financial stability.

Connected Economic Concepts

Market Economy

market-economy
The idea of a market economy first came from classical economists, including David Ricardo, Jean-Baptiste Say, and Adam Smith. All three of these economists were advocates for a free market. They argued that the “invisible hand” of market incentives and profit motives were more efficient in guiding economic decisions to prosperity than strict government planning.

Positive and Normative Economics

positive-and-normative-economics
Positive economics is concerned with describing and explaining economic phenomena; it is based on facts and empirical evidence. Normative economics, on the other hand, is concerned with making judgments about what “should be” done. It contains value judgments and recommendations about how the economy should be.

Inflation

how-does-inflation-affect-the-economy
When there is an increased price of goods and services over a long period, it is called inflation. In these times, currency shows less potential to buy products and services. Thus, general prices of goods and services increase. Consequently, decreases in the purchasing power of currency is called inflation. 

Asymmetric Information

asymmetric-information
Asymmetric information as a concept has probably existed for thousands of years, but it became mainstream in 2001 after Michael Spence, George Akerlof, and Joseph Stiglitz won the Nobel Prize in Economics for their work on information asymmetry in capital markets. Asymmetric information, otherwise known as information asymmetry, occurs when one party in a business transaction has access to more information than the other party.

Autarky

autarky
Autarky comes from the Greek words autos (self)and arkein (to suffice) and in essence, describes a general state of self-sufficiency. However, the term is most commonly used to describe the economic system of a nation that can operate without support from the economic systems of other nations. Autarky, therefore, is an economic system characterized by self-sufficiency and limited trade with international partners.

Demand-Side Economics

demand-side-economics
Demand side economics refers to a belief that economic growth and full employment are driven by the demand for products and services.

Supply-Side Economics

supply-side-economics
Supply side economics is a macroeconomic theory that posits that production or supply is the main driver of economic growth.

Creative Destruction

creative-destruction
Creative destruction was first described by Austrian economist Joseph Schumpeter in 1942, who suggested that capital was never stationary and constantly evolving. To describe this process, Schumpeter defined creative destruction as the “process of industrial mutation that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one.” Therefore, creative destruction is the replacing of long-standing practices or procedures with more innovative, disruptive practices in capitalist markets.

Happiness Economics

happiness-economics
Happiness economics seeks to relate economic decisions to wider measures of individual welfare than traditional measures which focus on income and wealth. Happiness economics, therefore, is the formal study of the relationship between individual satisfaction, employment, and wealth.

Oligopsony

oligopsony
An oligopsony is a market form characterized by the presence of only a small number of buyers. These buyers have market power and can lower the price of a good or service because of a lack of competition. In other words, the seller loses its bargaining power because it is unable to find a buyer outside of the oligopsony that is willing to pay a better price.

Animal Spirits

animal-spirits
The term “animal spirits” is derived from the Latin spiritus animalis, loosely translated as “the breath that awakens the human mind”. As far back as 300 B.C., animal spirits were used to explain psychological phenomena such as hysterias and manias. Animal spirits also appeared in literature where they exemplified qualities such as exuberance, gaiety, and courage.  Thus, the term “animal spirits” is used to describe how people arrive at financial decisions during periods of economic stress or uncertainty.

State Capitalism

state-capitalism
State capitalism is an economic system where business and commercial activity is controlled by the state through state-owned enterprises. In a state capitalist environment, the government is the principal actor. It takes an active role in the formation, regulation, and subsidization of businesses to divert capital to state-appointed bureaucrats. In effect, the government uses capital to further its political ambitions or strengthen its leverage on the international stage.

Boom And Bust Cycle

boom-and-bust-cycle
The boom and bust cycle describes the alternating periods of economic growth and decline common in many capitalist economies. The boom and bust cycle is a phrase used to describe the fluctuations in an economy in which there is persistent expansion and contraction. Expansion is associated with prosperity, while the contraction is associated with either a recession or a depression.

Paradox of Thrift

paradox-of-thrift
The paradox of thrift was popularised by British economist John Maynard Keynes and is a central component of Keynesian economics. Proponents of Keynesian economics believe the proper response to a recession is more spending, more risk-taking, and less saving. They also believe that spending, otherwise known as consumption, drives economic growth. The paradox of thrift, therefore, is an economic theory arguing that personal savings are a net drag on the economy during a recession.

Circular Flow Model

circular-flow-model
In simplistic terms, the circular flow model describes the mutually beneficial exchange of money between the two most vital parts of an economy: households, firms and how money moves between them. The circular flow model describes money as it moves through various aspects of society in a cyclical process.

Trade Deficit

trade-deficit
Trade deficits occur when a country’s imports outweigh its exports over a specific period. Experts also refer to this as a negative balance of trade. Most of the time, trade balances are calculated based on a variety of different categories.

Market Types

market-types
A market type is a way a given group of consumers and producers interact, based on the context determined by the readiness of consumers to understand the product, the complexity of the product; how big is the existing market and how much it can potentially expand in the future.

Rational Choice Theory

rational-choice-theory
Rational choice theory states that an individual uses rational calculations to make rational choices that are most in line with their personal preferences. Rational choice theory refers to a set of guidelines that explain economic and social behavior. The theory has two underlying assumptions, which are completeness (individuals have access to a set of alternatives among they can equally choose) and transitivity.

Conflict Theory

conflict-theory
Conflict theory argues that due to competition for limited resources, society is in a perpetual state of conflict.

Peer-to-Peer Economy

peer-to-peer-economy
The peer-to-peer (P2P) economy is one where buyers and sellers interact directly without the need for an intermediary third party or other business. The peer-to-peer economy is a business model where two individuals buy and sell products and services directly. In a peer-to-peer company, the seller has the ability to create the product or offer the service themselves.

Knowledge-Economy

knowledge-economy
The term “knowledge economy” was first coined in the 1960s by Peter Drucker. The management consultant used the term to describe a shift from traditional economies, where there was a reliance on unskilled labor and primary production, to economies reliant on service industries and jobs requiring more thinking and data analysis. The knowledge economy is a system of consumption and production based on knowledge-intensive activities that contribute to scientific and technical innovation.

Command Economy

command-economy
In a command economy, the government controls the economy through various commands, laws, and national goals which are used to coordinate complex social and economic systems. In other words, a social or political hierarchy determines what is produced, how it is produced, and how it is distributed. Therefore, the command economy is one in which the government controls all major aspects of the economy and economic production.

Labor Unions

labor-unions
How do you protect your rights as a worker? Who is there to help defend you against unfair and unjust work conditions? Both of these questions have an answer, and it’s a solution that many are familiar with. The answer is a labor union. From construction to teaching, there are labor unions out there for just about any field of work.

Bottom of The Pyramid

bottom-of-the-pyramid
The bottom of the pyramid is a term describing the largest and poorest global socio-economic group. Franklin D. Roosevelt first used the bottom of the pyramid (BOP) in a 1932 public address during the Great Depression. Roosevelt noted that – when talking about the ‘forgotten man:’ “these unhappy times call for the building of plans that rest upon the forgotten, the unorganized but the indispensable units of economic power.. that build from the bottom up and not from the top down, that put their faith once more in the forgotten man at the bottom of the economic pyramid.”

Glocalization

glocalization
Glocalization is a portmanteau of the words “globalization” and “localization.” It is a concept that describes a globally developed and distributed product or service that is also adjusted to be suitable for sale in the local market. With the rise of the digital economy, brands now can go global by building a local footprint.

Market Fragmentation

market-fragmentation
Market fragmentation is most commonly seen in growing markets, which fragment and break away from the parent market to become self-sustaining markets with different products and services. Market fragmentation is a concept suggesting that all markets are diverse and fragment into distinct customer groups over time.

L-Shaped Recovery

l-shaped-recovery
The L-shaped recovery refers to an economy that declines steeply and then flatlines with weak or no growth. On a graph plotting GDP against time, this precipitous fall combined with a long period of stagnation looks like the letter “L”. The L-shaped recovery is sometimes called an L-shaped recession because the economy does not return to trend line growth.  The L-shaped recovery, therefore, is a recession shape used by economists to describe different types of recessions and their subsequent recoveries. In an L-shaped recovery, the economy is characterized by a severe recession with high unemployment and near-zero economic growth.

Comparative Advantage

comparative-advantage
Comparative advantage was first described by political economist David Ricardo in his book Principles of Political Economy and Taxation. Ricardo used his theory to argue against Great Britain’s protectionist laws which restricted the import of wheat from 1815 to 1846.  Comparative advantage occurs when a country can produce a good or service for a lower opportunity cost than another country.

Easterlin Paradox

easterlin-paradox
The Easterlin paradox was first described by then professor of economics at the University of Pennsylvania Richard Easterlin. In the 1970s, Easterlin found that despite the American economy experiencing growth over the previous few decades, the average level of happiness seen in American citizens remained the same. He called this the Easterlin paradox, where income and happiness correlate with each other until a certain point is reached after at least ten years or so. After this point, income and happiness levels are not significantly related. The Easterlin paradox states that happiness is positively correlated with income, but only to a certain extent.

Economies of Scale

economies-of-scale
In Economics, Economies of Scale is a theory for which, as companies grow, they gain cost advantages. More precisely, companies manage to benefit from these cost advantages as they grow, due to increased efficiency in production. Thus, as companies scale and increase production, a subsequent decrease in the costs associated with it will help the organization scale further.

Diseconomies of Scale

diseconomies-of-scale
In Economics, a Diseconomy of Scale happens when a company has grown so large that its costs per unit will start to increase. Thus, losing the benefits of scale. That can happen due to several factors arising as a company scales. From coordination issues to management inefficiencies and lack of proper communication flows.

Economies of Scope

economies-of-scope
An economy of scope means that the production of one good reduces the cost of producing some other related good. This means the unit cost to produce a product will decline as the variety of manufactured products increases. Importantly, the manufactured products must be related in some way.

Price Sensitivity

price-sensitivity
Price sensitivity can be explained using the price elasticity of demand, a concept in economics that measures the variation in product demand as the price of the product itself varies. In consumer behavior, price sensitivity describes and measures fluctuations in product demand as the price of that product changes.

Network Effects

negative-network-effects
In a negative network effect as the network grows in usage or scale, the value of the platform might shrink. In platform business models network effects help the platform become more valuable for the next user joining. In negative network effects (congestion or pollution) reduce the value of the platform for the next user joining. 

Negative Network Effects

negative-network-effects
In a negative network effect as the network grows in usage or scale, the value of the platform might shrink. In platform business models network effects help the platform become more valuable for the next user joining. In negative network effects (congestion or pollution) reduce the value of the platform for the next user joining. 

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