Ratios are comparisons
A raw number rarely tells you much. A ratio compares two numbers to create a signal: how easily a business pays short-term bills, how efficiently it turns capital into profit, and how much it relies on debt.
Ratios are only meaningful against something else. Compare a company with its own history, with close competitors, or with an industry benchmark.
Key points
- Liquidity: can the business meet short-term obligations?
- Profitability: how much profit does each taka of sales or capital produce?
- Leverage: how much of the business is funded by debt?
Four ratios worth knowing
Current ratio = Current assets ÷ Current liabilities
A quick read on short-term financial strength.
Gross margin = (Revenue − COGS) ÷ Revenue
The share of each sale left after direct costs.
ROE = Net income ÷ Shareholders' equity
Profit generated for each unit of owners' capital.
D/E = Total debt ÷ Shareholders' equity
How much debt the business carries relative to equity.
Read the ratios as a group. A very high current ratio can mean idle cash or slow inventory. A high ROE can come from strong profit or simply from heavy borrowing.
A worked comparison
A business has current assets of ৳420,000 and current liabilities of ৳260,000, so its current ratio is 1.62. It holds ৳1.62 of short-term resources for every ৳1 of short-term obligations.
Net income of ৳90,000 on equity of ৳600,000 gives an ROE of 15%. On its own that looks healthy, but if the same business carries a high debt load, the return is being amplified by borrowing.
Where ratios mislead
Ratios depend on accounting choices. Two firms can report very different numbers because of how they value inventory or recognise revenue. Seasonal businesses look stronger or weaker depending on the month you measure.
Use ratios to ask better questions, not to deliver verdicts. A number that stands out is a prompt to look at the underlying detail.
Key points
- Always benchmark against peers or history.
- Ratios describe; they do not explain.
- Check the accounting behind an unusual result.
02 / Calculate
Measure the cash cycle.
Enter balances and annual flows to see net working capital, the current ratio, and how long cash stays tied up.
A retailer holding inventory and offering short credit to trade customers.
Cash conversion cycle
79days
Net working capital is ৳1.60 L. Cash is tied up for 79 days before it returns through sales and collection.
Current ratio
1.62×
Net working capital
৳160,000.00
Where the days come from
Cash conversion cycle = inventory days + receivable days − payable days = 84.2 + 36.5 − 42.1 = 78.6 days.
Days are calculated from annual flows using a 365-day year. Averages are more accurate than year-end balances when the business is seasonal.
03 / Apply
Two retailers, one decision
An investor compares two retailers. Alpha has a current ratio of 2.4 but slow-moving inventory. Beta has a current ratio of 1.1 but collects cash quickly and holds little stock.
The assumptions
- Both companies operate in the same industry.
- The current ratio uses the same definition for each.
- Inventory quality is similar in the accounting treatment.
What to take away
01
A higher current ratio is not automatically better.
02
Speed of cash collection can matter more than the headline ratio.
03
Combine liquidity, profitability, and leverage before deciding.
Your turn
0 of 3 answered
01Question
Current assets are ৳420,000 and current liabilities are ৳260,000. What is the current ratio? Round to two decimals.
02Question
Net income is ৳90,000 and shareholders' equity is ৳600,000. What is ROE as a percentage? Round to one decimal.
03Question
Which ratio best measures how much a business relies on borrowing?
Take it into the Lab
Experiment with the same idea.
The Lab turns this topic into a workspace: change the drivers, watch the statements move, and see the consequence before you commit to a decision.
What-if analysis
Change price, cost, and working capital. Watch margins, return, and risk move together.
Open the labFormula lab
Understand, manipulate, observe, solve, then apply the formula to a decision.
Walk the formulaStatement playground
See how one driver propagates through the income statement, balance sheet, and cash flow.
Open the playgroundSources & further reading
OpenStax · Principles of Finance (free textbook) ↗Educational sample content. Worked examples use hypothetical figures. Dates refer to the note's latest content update.