1. Profitability ratios

Profitability ratios help to check the capacity of the company to generate profits. It also tests the quality of management of the company. This involves ratios like EBITDA margin, PAT margin, ROE, ROA & ROCE.

a. EBITDA- Earnings Before Interest, Tax, Depreciation & Amortisation Margin: This ratio indicates the operating profit margin,i.e., the profits generated by conducting purely business activities.

EBITDA Margin = EBIDTA / (Total Income – Other Income)

b. PAT Margin: PAT Margin is calculated at the end.PAT is profit after tax & is calculated by deducting operating,non-operating expenses & tax expenses. It's the final figure of the profit available for shareholders.

PAT Margin = PAT/Total Revenues   

c. Return On Equity (ROE): ROE is a vital ratio for investors. As the name suggests, it calculates the % of return generated for every rupee of the capital invested. ROE is calculated as Profits available for shareholders / Shareholders' Equity​

d. Return On Assets(ROA): ROA indicates the efficiency with which the company deploys its assets. A good company does not invest in assets that can't generate revenue for the company. Therefore, the higher the ROA, the better is the company.

ROA=[Net income + interest* (1- tax rate)] / Total assets

e. Return on Capital Employed (ROCE): It indicates the profit generated on total capital employed, i.e., debt + equity.

ROCE=PBIT (Profit before Interest & tax) / total capital employed.

2. Leverage ratios

Leverage ratios indicate the overall debt status of the company. However, leverage ratios can prove to be a mixed blessing. In some cases, higher debt can indicate that the company is confident about using the debt to generate higher profits by exploiting new opportunities & it can also indicate that the company manages its debt poorly & the interest cost is eating up all the profits. Therefore it is important to interpret the debt ratios carefully. There are four leverage ratios:

a. Interest Coverage Ratio: -  The interest coverage ratio indicates how much the company is earning against interest expenses. In simple terms, it indicates whether taking a loan was a good option or not or if the company can pay interest on the amount borrowed by deploying the loan amount.

Interest coverage ratio = EBIT / Interest payment

b. Debt to asset ratio: -  This ratio helps to understand the financial structure of the company. The debt to asset ratio indicates how much of the total assets are financed by loans & debt capital.

Debt to asset = Total Debt / Total assets

c. Financial Leverage Ratio: -  The financial leverage ratio indicates how much of the total assets are financed by equity capital or to what extent assets are supported by equity.

Financial leverage ratio = Average total assets / average total equity.

3. Valuation ratios

The term value of something means the price or its worth. Valuation ratios help to compare the market price of the share & its actual worth. Valuation ratios are essential because entering into a good company at the right price is better than entering into the best high-valued shares. The important valuation ratios are: Price to sales ratio, price to book value ratio, price to earnings ratio

a. PE (Price to earnings) ratio: -  The PE ratio is the widely used ratio. Price to earnings ratio = Current market price / EPS. Earnings per share are the ratio that calculates the profitability of the company on a per-share basis

b. Price to sales ratio: -  Price to sales ratio is helpful to value the companies in an industry that are facing some cyclical issues in their earnings cycle.E.g.huge write-off of some costs due to the government's new policy. In such a case, the profits will not show an accurate picture of the performance of the companies. Here comes the role of price to sales ratio.

Price to sales ratio: Current market price of the share (CMP) / sale per share

b. Price to book value ratio: -  BV (Book value) of the company means the amount of money a company will have after selling off all the assets & paying off all the debts. It is the fund available for shareholders. It is the minimum value that equity shareholders get if the company goes into liquidation. Book value = [Share capital + (all reserves - revaluation reserve) / total number of shares]

Price to book value ratio = market price of the share/book value of the share

4. The index valuation

The two indexes related to bse & nifty are Sensex & nifty 50, respectively. The index valuation indicates whether the market is over-valued or under-valued. So, for example, in the case of nse nifty, instead of studying the top 50 companies individually, one can study the index & get a picture of the market.

4. Operating ratios

The operating profit is also called 'Management Ratios' as they indicate the efficiency of the company's operational activities. These are the asset management ratios that show how efficiently the management manages the assets of the companies. To better interpret the operating ratios, compare the ratios with the company's competitors or the company's past year ratios. Following are some of the operating ratios:

a. Fixed Asset Turnover ratio: -  Fixed assets include plant & machinery, equipments & properties. The fixed asset ratio turnover indicates the revenue generated against its investment in fixed assets

Fixed assets turnover = Operating revenues / total average asset

b. Working capital turnover: -  Working capital means the capital required by the firm to run its day-to-day business.It involves cash,inventory ,receivables,etc. The well-managed company finances its working capital from current liabilities.

Working capital = Current assets – Current liabilities

c. Total Assets Turnover: -  Total assets means fixed assets + current assets. The total assets turnover ratio indicates the company's capability to generate revenue with the given investment in assets.

Total asset turnover ratio = operating revenue / average total assets.

d. Inventory Turnover ratio: -  The number of times a company needs to refill or reload the stock of finished goods in certain time intervals is called inventory turnover

Inventory turnover = COGS / average inventory
COGS = Cost of goods sold

e. Inventory Number of days: -  It provides the number of days it takes for the company to sell off the inventory from the day it was ready to be sold. A lesser number of days means the product is moving at a faster pace & it's good for the company.

Inventory number of days = 365 / Inventory turnover

f. Accounts receivable turnover ratio: -  This ratio indicates how quickly the company converts its debtors or accounts receivables into cash.

Accounts receivable turnover ratio = Revenue / average receivables

g. Day sales outstanding / Average collection period/day sales in receivables: -  The average collection period indicates the time taken by a company to receive payments receivable from clients or customers.

Average collection period – 365 / Receivable turnover ratio