Income statement ratios are the ratios that analyze the company’s performance in the market during a period of time. These ratios usually measure the company’s ability in utilizing its capital and assets in order to generate sales and profit.
Although the financial statements, such as income statement and balance sheet, show the users how much profit the company made during the year, as well as how good is the current condition of the company, it did not show the full picture of how well the company performs during the period.
This is why understanding the income statement ratios are crucial for users of financial statements as it would help the users to analyze the information provided in the financial statements and gain a better understanding of how well the company was doing.
Also, it is more useful to compare these ratios to the previous period or other companies in the same industry. This would tell how well the company performs during the accounting period comparing to the previous period or its competitors.
The nine income statement ratios below are the ratios that can be calculated using the publicly available financial statements of the company.
1
Gross Profit Margin
(Revenues – COGS) / Revenues
2
Operating Profit Margin
Operating Profit / Revenues
3
Net Profit Margin
Net Profit / Revenues
4
Return on Assets
Net Profit / Average Assets
5
Return on Equity
Net Profit / Average Equity
6
Assets Turnover
Sales / Average Assets
7
Interest Coverage Ratio
Earnings before Interest and Tax / Interest Expenses
8
Earnings Per Share
(Net Profit – Preferred Dividends) / Common Shares
9
Price-Earnings Ratio
Market Value per Share / Earnings per Share
For example, we have the balance sheet and income statement of ABC Limited as below.
*Assume number of shares = 50,000; preferred dividend =0; market value per share = $2.5
What are the income statement ratios for ABC Limited in 2018?
With the balance sheet and income statement above we can calculate the ratios as below
Gross Profit Margin
Operating Profit Margin
Net Profit Margin
Return on Assets
= 15,360 / (157,287 + 150,765) / 2
Return on Equity
= 15,360 / (109,932 + 94,572)/2
= 139,570 / (157,287 + 150,765)/2
Interest Coverage Ratio