Do you have a 401k or a defined benefit plan or other retirement pension plan, and have no idea which investment options are best for you? Are you trying to determine which individual stocks to invest in? The main information included with all of your investment choices includes financial statements. Ratios are one of the many ways to analyze a company's financial statements. Within ratios, there are many ways to further disaggregate information. Ratios also differ depending on industry. In this article, we'll look at some of the more common ratios for a manufacturing entity with a simple financing structure to understand the basics so we can build more complex analyses later on.

Let's start with income statement ratios since most people go straight to this statement to see if a company is making money. One of the common ratios is the gross margin.

Gross margin % = (sales - cost of sales)/sales

Generally the higher the better because that means there are revenues in excess of the costs of producing and transporting a product that's available for other expenses such as salaries, research and development (R&D), interest on debt, and taxes.

The operating profit margin is also a key ratio. Following the gross margin on an income statement are other operating income and expenses disclosed by its significant contributors such as salaries and R&D.

Gross margin plus other income minus operating expenses equal Operating Income or Income Before Taxes. To calculate the operating profit margin, divide operating income by sales.

Operating margin % = operating income/sales.

Is the company that you're interested in profitable? Is there income after Operating Income and Taxes? If so, then there's net income (NI).

Profit margin % = net income/sales

Some companies find that it's more meaningful to compute this percentage after interest and before tax.

Here are some of the more common balance sheet ratios.

Return on equity, ROE, is an indicator of how well management uses the funds invested by the company's shareholders to generate returns. Over time, the value of a company's equity is determined by the relationship between its ROE and its cost of capital. Firms that generate ROEs greater than its cost of capital should have market values in excess of book value.

ROE = NI/avg common shareholders' equity(SHE)*

Average common SHE = (beginning SHE + ending SHE)/2

Return on assets, ROA, is an indicator of management's performance in using assets, and can be further disaggregated into receivables turnover and inventory turnover.

ROA = NI/avg total assets*

*average total assets = (beginning total assets +ending total assets)/2

Accounts receivable (AR) turnover gives an indication of how quickly receivables are converted into cash. The calculation is:

AR turnover = Net sales on account/average accounts receivable

Divide the turnover into 365 days to calculate the average number of days receivables are outstanding.

Inventory turnover is used to help determine the minimum amount of inventory to have on hand to sell without holding too much and tying up capital to finance it. The calculation is:

Inventory turnover = Cost of goods sold/average inventory

Divide the turnover into 365 days to calculate the average number of days inventory is on hand.

Each of these results needs context to be meaningful and actionable. Compare it to prior periods and if available, to what the company forecasts it will be. It's also important to compare these ratios to competitors and other companies in the same industry.