Ratio analysis is analyzing a company based on calculating a set of financial ratios. Common financial ratios include the current ratio, return on assets, and debt to equity ratio.
Return on Assets
Return on assets (ROA) is a financial ratio on how profitable a company is based on its assets. The most common formula divides net income by total assets. ROA is shown as a percentage.
Assume a company has net income of $5,000 and total assets of $40,000. The ROA is 5,000 / 40,000 = 12.5%
Return on Equity
Return on equity (ROE) is a financial ratio on how profitable a company is based on its stockholders’ equity. The ROE formula divides net income by total equity. ROE is always presented as a percentage.
Assume a company has net income of $5,000 and total equity of $25,000. The ROA is 5,000 / 25,000 = 20.0%
Return on Investment
Return on investment (ROI) is a financial ratio on how profitable a project is based on its initial investment. The ROI formula divides net profit by total investment. Net profit equals Current Value of Investment + Income – Initial Investment and Costs. ROI is always shown as a percentage.
Assume Zebra Co. purchased stock for $50,000. After one year, the stock paid dividends of $1,500 and was worth $55,000. The net profit is 55,000 + 1,500 – 50,000 = 6,500. So, the ROI is 6,500 / 50,000 = 13.0%
Revenue occurs when a business receives assets by selling a product or service. Revenues are one of the five types of accounts. Revenues are included on the income statement. Revenues are also called income or gains.
Rule of 72
The Rule of 72 is an estimate of how fast an investment doubles given a fixed interest rate. It approximates a compound interest problem of an account that grows exponentially. Rule of 72 formula: Years to double = 72 / Interest Rate.
For example, if an account earns 8%, how fast will the account double? 72 / 8 = 9 years. So at 8%, an investment would double in approximately 9 years. Note: the 8% is used in the formula as a whole number, or 8.