🕯️ [INT. FINACADEMICS OFFICE – LATE EVENING]
Watson slumps into a leather chair, numbers swirling in his notebook. Sherlock peers at a ledger, a half-smirk playing on his face.
WATSON:
Sherlock, I’m buried under numbers! Ratios here, percentages there—Current Ratio, Return on Equity, Debt-to-Whatever… it’s like decoding a secret language of accountants.
SHERLOCK:
Ah, Watson. That is precisely what it is. Financial ratios are compact codes—mathematical fingerprints. They may seem dull, but each holds a clue, a motive… a truth. One glance, and you’ll know if a business is surviving, thriving, or simply… bluffing.
📚 Why Ratios Matter
Financial ratios are shortcuts to judgment. They allow comparisons between companies, track performance trends, and raise red flags without having to inspect every line item. They fall into three key families:
- Liquidity Ratios – Can we pay our bills?
- Leverage Ratios – Are we borrowing too much?
- Profitability Ratios – Are we actually making money?
💧 1. Liquidity Ratios
Current Ratio
Formula: Current Assets / Current Liabilities
✔ Over 1 = healthy; under 1 = trouble.
Sherlock: “Liquidity, Watson, is like air. You don’t think about it—until it’s gone.”
Quick Ratio (Acid Test)
Formula: (Current Assets – Inventory) / Current Liabilities
Sherlock: “Inventory, Watson, may look valuable… until no one wants it.”
⚖️ 2. Leverage Ratios
Debt-to-Equity Ratio
Formula: Total Liabilities / Shareholder Equity
Sherlock: “Debt isn’t evil. It’s a scalpel. In skilled hands, it’s useful. In others… a weapon.”
Interest Coverage Ratio
Formula: EBIT / Interest Expense
✔ <1 = danger zone; >3 = comfort zone.
Sherlock: “If the interest bill eats the profits, you’re feeding a bank, not running a business.”
💰 3. Profitability Ratios
Gross Profit Margin
Formula: (Revenue – COGS) / Revenue
Sherlock: “Revenue is vanity. Profit is reality. Margin, Watson… is intelligence.”
Net Profit Margin
Formula: Net Income / Revenue
Compare across years and peers to assess efficiency.
Return on Equity (ROE)
Formula: Net Income / Shareholder Equity
Sherlock: “A high ROE says: ‘We know what we’re doing with your money.’ A low one? Not so much.”
🧰 A Mini-Case: Compare Two Businesses
| Metric | Company A | Company B |
|---|---|---|
| Net Income | 500,000 | 500,000 |
| Revenue | 5,000,000 | 2,000,000 |
| Equity | 2,000,000 | 500,000 |
| Debt | 1,000,000 | 2,000,000 |
| EBIT | 700,000 | 600,000 |
| Interest Expense | 100,000 | 300,000 |
| Net Margin | 10% | 25% |
| ROE | 25% | 100% |
| Interest Coverage | 7 | 2 |
Sherlock: “B looks more profitable. But it’s skating on debt. A’s margin is lower—but its cushion is thicker.”
⚠️ Red Flags to Watch
- High ROE from excessive debt
- Great margin but poor operating cash flow
- Receivables inflating liquidity ratios
🧠 Sherlock’s Final Word
“Ratios, Watson, are like clues. One tells you something. But three or four together? They tell you everything. So next time someone shows you a glossy annual report… don’t get dazzled. Run the ratios. Ask what they reveal—and what they don’t.”
“It is a capital mistake to theorize before one has data.”
— Sherlock Holmes, A Study in Scarlet