The
cash ratio
is equal to cash and cash equivalent items divided by the current liabilities.
The
cash ratio
is the most conservative of the liquidity ratios because it only takes into account
the most liquid form of a current asset—that is, cash and cash equivalents.
The first ratio that is generated from the income statement is the
gross profit margin
, which is
computed as the gross profit divided by sales and shows the percentage of profit remaining after
the cost of a good has been paid (Gross profit / Sales).
The second ratio generated is the
operating profit margin
, which is found by dividing the
operating profit by sales and shows the percentage remaining after deducting the operating
expenses (Operating profit / Sales).

The final ratio that is directly computed from the income statement is the
net profit margin
. This
ratio is computed by dividing the earnings available for common shareholders by sales (Earnings
available for common shareholders / Sales). This is of particular interest because it is effectively
showing the bottom-line profitability of a firm.
The other two most commonly referenced
profitability ratios
are the
return on equity (ROE)
and the
return on asset (ROA).
The
ROE
is found by dividing the earnings available for common stockholders by the common
stock equity. This tells the analyst of the return on every $1 of equity. For example, if the ROE is
computed as 7.6%, this would mean that for every $1 of equity, the firm was able to generate
7.6 cents, or 7.6%.
The
ROA ratio
is found by dividing the earnings available for common stockholders by the total
assets. This ratio tells the analyst of the return on every $1 of assets. For example, if the ROA is
11.1%, this would mean that for every $1 of equity, the firm was able to generate 11.1 cents, or
11.1%. This ratio is significant because it shows how efficiently a firm is using assets to generate
sales.

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- Summer '13
- Liquidity, Financial Ratio, Generally Accepted Accounting Principles, analyst