The ratio starts with a question
Source data come from the particular organization’s forms and notes, while market numerators are data for a specified date. SEC guidance on reading a 10-K helps distinguish financial documents, management discussion and risks; it concerns the United States. NYU’s “The Anatomy of a Multiple” emphasizes matching numerator and denominator. The formulas below are defined educational choices, not the only mandatory methodology.
Five families and five different tasks
| Family | Educational formula | Question | What remains outside it | |---|---|---|---| | Liquidity | Current assets / current liabilities | How do current balances compare? | Time needed to turn inventory into cash | | Turnover | Average trade receivables / credit sales × 365 | What is the conditional scale of the payment deferral? | Age of a specific debt and seasonality | | Profitability | Net income / revenue | What share of sales remained as a result? | Need for new investment | | Stability and servicing | Debt / equity; EBIT / interest | How is financing structured and is interest covered? | Debt-principal calendar and access to money | | Market valuation | Capitalization / earnings attributable to ordinary shareholders | How has the market valued one unit of this result? | Future growth, risk and intrinsic value |
These are not independent scores in one questionnaire. Improving liquidity by accumulating unsold goods can coincide with poorer asset quality. High return on sales does not mean high return on capital if sales require a very large equipment base. A low P/E can reflect cyclically high earnings rather than a sustainably cheap business.
One company in several dimensions
All amounts are conditional and the period is a full year. Current assets are 240, current liabilities 120, revenue and credit sales 600, average trade receivables 60. Net income attributable to ordinary shareholders is 48, average equity 200, defined interest-bearing debt 300, ending equity 200, EBIT 90, interest expense 30 and capitalization on the selected date 480. There are no preferred interests, tax differences in the requirements or perimeter changes.
The current ratio is 2, conditional receivable days are 36.5, net margin is 8%, ROE is 24%, debt to ending equity is 1.5, interest coverage is 3 and P/E is 10. The figures answer different questions and use different bases. ROE uses an average base for the year; debt uses the balance on the date. Labels matter as much as calculations. The 24% cannot be compared with another ROE calculated on sharply reduced ending equity without explanation.
Where the simple formula breaks
If annual results include a large gain from selling a division, margin and P/E describe more than repeatable operations. If equity is negative, a formally positive ROE with a loss is not evidence of efficiency. If interest is capitalized or EBIT is adjusted, check both measures. Division by a small value creates an unstable ratio; division by zero does not produce a meaningful “infinitely good” result.
For turnover days, align taxes and sales composition with the intended requirements. Inventory usually calls for cost of sales rather than revenue because the amounts use different valuation bases. For cash balances, check access restrictions. IAS 7 separates operating, investing and financing cash flows; a positive total inflow from new borrowing does not confirm a sustainable operating model.
Market measures need their own passport
Capitalization relates to the owners of the corresponding equity; EV relates to a different claims base. EV therefore cannot be divided mechanically by earnings after interest, and capitalization cannot be compared with the whole-business result before payments to creditors. For EPS, align share class, weighted share count and profit type. When comparing price with book equity, distinguish market date from reporting date.
Historical, trailing and forecast earnings are not interchangeable. A forward ratio contains someone else’s expectation, while a normalized ratio contains a choice of adjustments. Keep source date, formula, perimeter, currency and units in the table after visualization. If data are unknown, an empty cell with a reason is better than a number from another period.
Diagnosis is hypothesis checking
Start with a deviation, propose several explanations and seek support in a note or movement of balances. Growth in receivable days may mean a new payment term, seasonal delivery or collection difficulty. Only the last hypothesis directly concerns worsening payments, and it must be checked. A ratio helps select the next document; it does not replace that document.
Do not apply one set of thresholds to a bank, retailer and equipment manufacturer. The map helps formulate questions about the business model, not issue a universal diagnosis. Continue with [peer comparability](/guides/peer-comparison/), [cash conversion cycle](/guides/cash-conversion-cycle-days/) and [financial leverage](/guides/leverage-interest-cash-coverage/). An investment decision does not follow from mechanically adding these ratios.