Major financial ratios of retail companies

Use retail financial ratios

The financial ratios of companies in the retail industry help management to conduct sales operations. Investors analyze these financial ratios to determine the retail company’s long-term safety, short-term efficiency, and overall profitability. Financial ratios also help reveal the retail company’s success in selling inventory, product pricing, and overall business operations. The following are the key ratios of the retail industry.

Current ratio

The current ratio is measured by dividing the company’s current assets by its current liabilities. This financial indicator measures the company’s ability to repay short-term debt. A current ratio greater than 1 indicates that the company can use the most liquid assets to repay short-term debt. For investors, the current ratio measures the organization’s liquidity and short-term cash flow stability during the potential seasonal fluctuations common in retail or any unplanned transient short-term events that require immediate cash payments.

Quick ratio

The quick ratio is calculated by dividing the company’s cash and accounts receivable by its current liabilities. This ratio is similar to the current ratio, but the quick ratio limits the types of assets that cover liabilities. Therefore, the quick ratio can more accurately measure the company’s immediate liquidity. If a company is forced to liquidate its assets to pay bills, then companies with higher quick ratios will be forced to sell fewer assets. From an investor’s point of view, the quick ratio can provide insight into the stability of the company’s immediate liquidity position.

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Gross profit margin

Gross profit margin is the profit rate calculated in two steps. First, the gross profit is calculated by subtracting the company’s cost of sales (COGS) from the company’s net income, and then dividing the gross profit by the net sales. This indicator is very insightful for management and investors on the markup earned by the product. From an investor’s point of view, a higher gross profit margin is desirable because more revenue is generated when an inventory is sold with a higher gross profit. Since all the products in the retail company are inventory products, the gross profit margin is related to each product in the retail store.

ROA is particularly important for retail companies because they rely on inventory to generate sales.

Inventory turnover

Inventory turnover rate is the net sales of a period divided by the average inventory balance of the same period, and it is an indicator to measure the efficiency of inventory management. Retail companies have inventory on hand to protect and protect. In addition, older inventory may become obsolete. Therefore, a higher inventory turnover rate is beneficial to management and investors. Low inventory turnover rate indicates that the company holds too much inventory or does not achieve sufficient sales and inefficiency. Or, the inventory turnover rate may be too high. For example, a larger ratio may indicate that the company is effectively ordering inventory but not receiving an order discount.

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Return on Assets

Return on assets (ROA) is a profitability indicator that measures how a company uses its assets to create income. This measure is particularly important for retail companies that rely on inventory to generate sales. The financial ratio is calculated by dividing the company’s total earnings by its total assets. Investors can compare the ROA of a retail company with the industry average to understand the company’s effectiveness in pricing and inventory turnover. For example, according to CSIMarket.com, the average ROA of the retail apparel industry in the third quarter of 2019 was 7.54%. If a company in the industry calculates an indicator of 7%, it may have too much inventory or not charge high enough prices compared to its competitors.

Interest coverage ratio

The interest coverage ratio is calculated by dividing the profit before interest and taxes (EBIT) by the average interest expense. Retail companies may be required to pay rent or interest on leases of goods, equipment, buildings, or other items needed for operations. The interest coverage ratio determines the extent to which a company can cover the interest it owes in a certain period of time. Investors can use this ratio to determine the stability of the company and its ability to pay interest expenses.

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EBIT

EBIT margin measures the ratio of EBIT to net income earned over a period of time. The company can use this financial ratio to determine the profitability of the goods sold without having to consider expenses that do not directly affect the product. Although the EBIT margin takes into account management and sales expenses, it eliminates some expenses that may distort the profitability of the product. From an investor’s point of view, the EBIT margin indicates the company’s ability to earn income.

Key points

  • Investors analyze financial ratios to determine the company’s overall profitability.
  • Financial ratios are based on accounting information disclosed by listed companies.
  • The key ratios in the retail industry are current ratio, quick ratio, gross profit margin, inventory turnover ratio, ROA, interest coverage ratio and pre-interest and tax margin.

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