Three lenses on financial health
| Category | Key ratios | What it tells you |
|---|---|---|
| Liquidity | Current ratio, quick ratio | Can the company meet short-term obligations? |
| Solvency | Debt-to-equity, times interest earned | Can the company meet long-term obligations? |
| Profitability | Gross margin, net margin, ROA, ROE | How efficiently does the company generate profit? |
Key formulas
- Current ratio = Current assets ÷ Current liabilities
- Quick ratio = (Current assets − Inventory − Prepaids) ÷ Current liabilities
- Return on equity (ROE) = Net income ÷ Average stockholders' equity
- Times interest earned = EBIT ÷ Interest expense
EXAMPLE: Current assets $500,000 (including $150,000 inventory and $20,000 prepaid expenses), current liabilities $250,000. Current ratio = $500,000 ÷ $250,000 = 2.0. Quick ratio = ($500,000 − $150,000 − $20,000) ÷ $250,000 = $330,000 ÷ $250,000 = 1.32.
EXAM TIP: The DuPont framework decomposes ROE = Net profit margin × Asset turnover × Financial leverage — useful for explaining why ROE changed, not just that it changed.