Investopedia

Reviewed by Khadija Khartit
Fact checked by Vikki Velasquez

Financial ratios can be used to assess a company’s capital structure and current risk levels, often in terms of a company’s debt level and risk of default or bankruptcy. Some of the financial ratios commonly used by investors and analysts to assess a company’s financial risk level and overall financial health include the debt-to-capital ratio, the debt-to-equity (D/E) ratio, the interest coverage ratio, and the degree of combined leverage (DCL). Let’s take a look at what they’re used for, how they’re calculated, and how they’re used.

Key Takeaways

• Financial risk ratios are analytical tools that consider a company or investment’s financial health to determine whether the potential for loss is likely.
• If a company uses revenues to repay debt, those funds cannot be invested elsewhere within the company to promote growth, making it a higher risk.
• The most common ratios used by investors to measure a company’s level of risk are the interest coverage ratio, the degree of combined leverage, the debt-to-capital ratio, and the debt-to-equity ratio.

What Are Financial Risk Ratios?

Financial risk ratios are tools that investors, creditors, and analysts can use to determine whether a company or investment is financially unstable—and just how unhealthy it is. These metrics help people understand whether the potential for loss is likely.

Whether a firm can manage its outstanding debt is critical to the company’s financial soundness and operating ability. Debt levels and debt management also significantly impact a company’s profitability, since funds required to service debt reduce the net profit margin and cannot be invested in growth.

Debt-to-Capital Ratio

The debt-to-capital ratio indicates a firm’s financial soundness by measuring leverage. This provides a basic picture of a company’s financial structure in terms of how it is capitalizing its operations. Put simply, the debt-to-ca ratio compares a company’s total short-term debt and long-term debt obligations with its total capital provided by both shareholders’ equity and debt financing.

To determine a company’s debt-to-capital ratio, you’ll need to find its total debt and its shareholders’ equity on its balance sheet, then plug them into the following formula:

Debt-to-Capital Ratio = Debt ÷ (Debt + Shareholders’ Equity)

Let’s say Company X has total debt of $200 million and $300 million in shareholders’ equity. Using the formula above, we can determine that Company X has a debt-to-capital ratio of 0.4 or 40%. This means that 40% of its capital assets are being funded by debt.

Lower debt-to-capital ratios are preferred because they indicate a higher proportion of equity financing to debt financing.

Debt-to-Equity (D/E) Ratio

The debt-to-equity ratio is a key financial ratio that provides a more direct comparison of debt financing to equity financing. This ratio is also an indicator of a company’s ability to meet outstanding debt obligations.

Debt-to-Equity Ratio = Debt ÷ Shareholders’ Equity

Using the figures from the example above, we can determine that Company X has a D/E ratio of about 0.67 or 67%.

A lower ratio value is preferred as this indicates the company is financing operations through its own resources rather than taking on debt. Companies with stronger equity positions are typically better equipped to weather temporary downturns in revenue or unexpected needs for additional capital investment. Higher D/E ratios may negatively impact a company’s ability to secure additional financing when needed.

Important

A higher D/E ratio may make it harder for a company to obtain financing in the future.

Interest Coverage Ratio

The interest coverage ratio is a basic measure of a company’s ability to handle its short-term financing costs. This ratio value reveals the number of times a company can make the required annual interest payments on its outstanding debt with its current earnings before interest and taxes (EBIT).

Interest Coverage = EBIT ÷ Interest Expense

Assume Company X has interest expenses of $100 million and EBIT of $200 million. Plugging the numbers into the formula, we can see that it has an interest coverage ratio of 2.

A relatively lower coverage ratio indicates a greater debt service burden on the company and a correspondingly higher risk of default or financial insolvency. Put simply, it means there’s a lower amount of earnings available to make financing payments, so the company is less able to handle any increase in interest rates.

An interest coverage ratio of 1.5 or lower is generally considered indicative of potential financial problems related to debt service. This is not the case with our Company X example. Keep in mind that an excessively high ratio can indicate the company is failing to take advantage of its available financial leverage.

Note

A company with an interest coverage ratio of 1.5 or lower is likely to face potential financial problems related to debt service.

Degree of Combined Leverage

The degree of combined leverage provides a more complete assessment of a company’s total risk by factoring in both operating and financial leverage. This leverage ratio estimates the combined effect of business risk and financial risk on the company’s earnings per share (EPS), given a particular increase or decrease in sales.

Calculating this ratio can help a company’s management team identify the best possible levels and the combination of financial and operational leverage for the firm.

DCL = % Change EPS ÷ % Change Sales

A firm with a relatively high level of combined leverage is seen as riskier than a firm with less combined leverage because high leverage means more fixed costs to the firm.

Why Are Financial Ratios Important?

Financial ratios are analytical tools that people can use to make informed decisions about future investments and projects. They help investors, analysts, and corporate management teams understand the financial health and sustainability of potential investments and companies. Commonly used ratios include the D/E ratio and debt-to-capital ratios.

What’s the Difference Between a Financial Ratio and a Liquidity Ratio?

Financial ratios are analytical tools that can be used to determine how well a company is performing and whether it is financially stable. A liquidity ratio, on the other hand, is a financial metric that indicates whether a company can pay its short-term financial obligations on time without having to raise capital.

What Are Some of the Most Common Income Statement Ratios?

Income statement ratios are financial metrics that are calculated using data from a company’s income statement. Some of the most common types of this class of ratios include earnings per share (EPS), gross profit margin, operating profit margin, and net profit margin.

The Bottom Line

Financial ratios are used in fundamental analysis to help value companies and estimate their share prices. Certain financial ratios can also be used to evaluate a firm’s level of risk, especially as it relates to servicing debts and other obligations over the short and long run.

This analysis is used by bankers to grant additional loans and by private equity investors to decide investments in companies and use leverage to pay back debt on their investments or augment their return on investments.

Reviewed by Ebony Howard
Fact checked by Michael Rosenston

Members of the U.S. Armed Forces should be aware of tax breaks available to them. To benefit you need to be in the Army, Marine Corps, Navy, Air Force, Space Force, Coast Guard, National Guard, or the military reserve.

Among the tax breaks you may receive, if you qualify, are postponement of tax deadlines, partial or fully tax-free pay, tax deductions, and other benefits around filing tax returns. Learning to take advantage of these tax breaks can help you make the most of your money and your benefits as a member of the military.

Key Takeaways

• Combat pay is partially or fully tax-free if you serve in a combat zone, and you receive automatic extensions on deadlines for filing your taxes.
• Most military bases offer tax preparation and filing assistance services during tax season.
• Some costs—such as moving expenses, reservists’ travel, and some uniforms—may entitle you to deductions when filing your taxes.

Helpful Tax Tips

When it comes to general information about your taxes, keep in mind the following two tips:

• Combat pay exclusion: Your combat pay is partially or fully tax-free if you serve in a combat zone. You may also qualify for this extension if you serve in support of a combat zone.
• Tax services: If preparing your taxes is the hardest part of tax season for you, seek help from the tax preparation and filing assistance services, MilTax, during tax season.

When Filing Your Taxes

When it comes to actually filing your taxes, note that you may qualify for extensions on deadlines and that you may have options when it comes to signing your return or choosing what to include as taxable income.

• Extensions: Military members who serve in a combat zone receive automatic extensions on deadlines for filing their taxes. You can receive extensions of time to file your tax return and pay your taxes.
• Earned Income Tax Credit (EITC): If you receive nontaxable combat pay, you can still choose to include it as part of your taxable income. If you do, it may boost your EITC, leading to a potentially larger refund.
• Joint returns: Spouses may be able to sign the tax form for a spouse who is absent due to certain military duties or conditions. You may need a power of attorney (POA) to file a joint return; the legal office at your installation maybe able to help you.

Deductions and Allowances

It’s important to be aware of the deductions and allowances you can include when filing your taxes. This can make a substantial difference in the amount you owe or are refunded, so be sure to take advantage of every option that you can.

• Moving expense deduction: Moving costs can be deducted using Form 3903. This usually only applies when the move is due to a permanent change in station.
• Reservists’ travel deduction: Members of the reserves can deduct unreimbursed travel expenses if their duties take them more than 100 miles from home. They can do this on Form 2106 (even if they do not itemize their deductions).
• Uniform deduction: Some uniforms that must be purchased cannot be worn while off duty. The cost and upkeep for these can be deducted. You must reduce your deduction by any allowance you get for these costs.
• Post-military life:  You may be able to deduct some job search expenses if you leave the military and seek other work, such as costs of travel, preparing a resume, job placement agency fees, and even moving fees.
• ROTC allowances: Some amounts paid to ROTC students in advanced training—such as allowances for education and subsistence—are not taxable. However, active duty ROTC pay and pay for summer advanced camp is taxable.

Other Tax Considerations

There are other tax considerations worth being aware of as well, including some that affect veterans or your dependents.

• Disabled veterans: Disabled veterans may be eligible to claim a federal tax refund if there was an increase in their percentage of disability from the Department of Veterans Affairs (this may include a retroactive determination) or if they are a combat-disabled veteran who is granted Combat-Related Special Compensation.
• Combat-Injured Veterans Tax Fairness Act of 2016: This law states that veterans who suffer injuries related to combat are not to be taxed if they receive a lump-sum disability severance payment from the Department of Defense. The Department of Defense must instruct you to amend your return if you were taxed on this payment.
• Death benefits: The death gratuity benefit paid to survivors of deceased Armed Forces members is not taxable.
• Dependent care flexible spending accounts: Service members can divert pre-tax money into a dependent care flexible spending account. This allows them to lower their taxable income while putting aside money to care for family.
• Education benefits: If you are serving or have served—and are receiving education benefits—these are excluded from taxation.

The Bottom Line

The Internal Revenue Service has an Armed Forces’ Tax Guide that covers everything about taxes for members of the armed forces in great detail.

Knowing as much as possible about the tax breaks that you can take advantage of as a member of the military will help you make the most of your money. Whether you are currently serving or are a veteran, there will always be tax considerations that you should review when filing your taxes to ensure that you are taking full advantage of all your benefits.

Investopedia & REAL SIMPLE research reveals how women are thinking about, talking about, and engaging with money.

As women are poised to inherit $31 billion of assets from older generations by 2033, a joint survey from Investopedia and REAL SIMPLE found this demographic needs more wealth-building guidance and shame-free support, even within friendships.

The 2024 Her Money Mindset Survey polled a representative sample of U.S. women to learn how women across generations and income levels are thinking about, talking about, and engaging with money. 

Key Takeaways

• On average, 63% of women’s income is directed to necessities and 64% of women have under $500 at the end of each month after their necessities are paid. 
• Only 39% of women are invested, and participation varies based on age, income level, and financial literacy.
• 1 in 5 women have helped someone cover a significant expense and are currently struggling to meet at least one expense of their own.
• While money talks between friends are fairly common, the level of detail shared (and how truthful those details are) varies.
• Overall, women are confident financial decision makers and want to learn about saving money and investing. 

“Too often, we’re discouraged from talking about money. We worry it might seem crass, impolite, or inappropriate. But experts agree that open conversations around our finances help normalize the topic, motivate us to save, and make complex situations less confusing,” said REAL SIMPLE Editor in Chief Lauren Iannotti. “Collaborating with Investopedia, we set out to uncover the barriers hindering women’s financial confidence because when we determine what’s holding us back, we can set a plan to move ahead.”

The study, which was conducted during a period of high inflation and ongoing economic uncertainty, found that even on a tight budget, women are generous, and actively seek out more information. They have more to learn—and talk about—but overall, women are resilient, confident money managers. 

Women Are Focused on Short-Term Finances

One thing that U.S. women have in common across generations and income levels is that the majority of monthly income (63%) is spent on necessities, including housing, transportation, healthcare, education, and child care. Another 20% goes to flexible spending, and approximately 17% helps fund their financial goals. 

Monthly bills are eating up a lot of dollars, too. The 2024 Her Money Mindset Survey found that 64% of women have just under $500 left each month after covering the necessities—$422 on average. Another 44% have less than $250 left each month. 

Overall, although most women are able to cover monthly expenses, 54% said they are currently struggling to cover at least one type of monthly expense. 

Most women surveyed (67%) carry some debt, too. Credit card debt is the most common, followed by mortgages and car loans. 

While stretching dollars, women are very aware of where their money is going, and have big short-term goals, too. Seventy-six percent of women keep an eye on where their money goes every month, while 72% are saving for short-term goals.

In addition to covering bills and other necessities, the most common three-year financial goals include saving for retirement, buying a car, and paying (or paying down) credit card debt. 

Some Women Are Investing, But Mindset Varies 

The narrative surrounding women investors is often one of underrepresentation and hesitance, but that is not the whole story. Women’s investment behavior is nuanced, and The 2024 Her Money Mindset survey highlights the interplay of age, income, and financial literacy in how women see themselves as investors. 

Overall, 39% of women surveyed currently hold investments. When you break that down further, the rate of women investors is higher among those in Generation X or older (42% of which currently hold investments). Women who make more than $75,000 annually are also more invested (58%), and are more likely to hold multiple types of investments.

Retirement accounts, stocks, and mutual funds are the most common types of investments held. Cryptocurrency is more popular among women who are millennials or younger, too.  

Important

51% of invested women are proud of an investment decision they have made. 

The survey asked women to share more about their investing decisions, and four main themes emerged from the anonymous responses: Women take pride in seeking professional help from financial advisors, teaching themselves about investing, discussing their strategies, and detailing the habits they have developed along the way. 

For example, one Gen X survey respondent said: 

“I am most proud of myself for investing part of my savings into the stock market and learning about everyday trends within the market.” 

What’s Holding Some Women Back?

Despite positive investing sentiment, knowledge gaps are hindering some women from investing—or even just thinking of themselves as investors. 

For example, a little over half of the women told Investopedia & REAL SIMPLE that they are not invested (53%), but 10% of those respondents went on to say they have a retirement account, such as a 401(k) or IRA. 

The reality is, if you hold such an account, you are in fact invested. 

Why aren’t more women investing? The most common reason reported was that women don’t feel like they have enough money to invest. Perhaps unsurprisingly, women with lower household incomes are more likely to cite this reason.  

Another reality? You don’t need thousands of extra dollars to start investing.

“Think about putting aside money to invest every month as another way you are actually paying yourself. Just like you wouldn’t work without getting paid, pay your future self—even if it’s just a little bit—every month,” said Investopedia Editor in Chief Caleb Silver. “Investing something as small as $50 a month can grow into tens of thousands of dollars by the time you retire. Start simple with index funds or ETFs, and watch your initial investments and their dividends compound over time.”

Aside from feeling like money may not spread far enough to pay bills and invest, fear and uncertainty impact women’s willingness to jump into investing with both feet: 29% of those who aren’t invested say it’s because they fear losing money, and 25% don’t know where to start. 

Women with higher household incomes are actually more likely to cite a lack of knowledge or a fear of losing money as their primary reason for not investing. 

There is curiosity, though: nearly 1 in 4 women say they want to learn more about investing. 

Women Are Financially Generous, Despite Own Struggles

Most women surveyed (67%) have acted as a financial supporter for someone in their life. That rate jumps to 73% for younger women, too.  

This level of generosity extends to smaller purchases, too. On an ordinary day, almost all women say they would pay for a friend’s meal, which has an average cost of $24. 

For many, generosity is not dependent on a woman’s financial well-being, either: 1 in 5 women said they have at one point helped someone cover a significant expense and are also currently struggling to cover housing expenses. 

If they need financial help themselves, women are actually more likely to have asked a friend for a loan before asking a significant other or family member. 

Money Conversations Are Complicated

When it comes to communicating about money, women have ambivalent feelings. The 2024 Her Money Mindset survey found that while there is often some degree of money talks happening between friends, the level of detail shared—and how truthful those details are—are a mixed bag. 

Overall, 70% of women say that they sometimes talk to their friends about money. Younger women (millennials and generation z) tend to be more comfortable talking about money matters with friends and those with household incomes above $75,000 are most likely to broach these topics with their friends.

The women we surveyed told us that talking about money with friends can lead to bonding, and a greater support system. Among those who talk to their friends about money, budgeting and planning for the future are the most common money conversation topics, and 1 in 3 have also discussed investing decisions with their friends. 

However, while the women we surveyed told us that talking about money with friends can lead to bonding and more support, sharing details is rare. Half (51%) of women who talk to their friends about money say they share very little about their own financial situation. 

Note

Fewer than 1 in 4 women who talk with their friends about money have shared with their friends how much money they make. 

Of those who will not discuss money with friends, most (54%) say it is because they feel it is not appropriate. This response is more common among women who are Gen X or older, while younger generations are more likely to avoid talking about money because it’s too awkward. 

Income differences and financial situations play the biggest role in women avoiding money conversations with friends. Fear of judgment and shame are common, especially among women with household incomes below $75,000 a year, and those in different financial situations than their peers. In some cases, these feelings result in lies or omissions. 

Here’s what some Her Money Mindset survey respondents across generations told us anonymously when asked to share a time they lied about money:

“I was embarrassed to share how much debt I had or how little I had in my bank account, so I lied.” -Gen Z woman (18-26 years old)

“I felt ashamed that I couldn’t pay off my student loan and credit card debt compared to some of my friends. The financial burden of helping out my parents (sharing expenses under the same roof) seemed to be the differentiator, since many of my friends had younger parents who were working and supporting them.” -Millennial woman (27-42 years old)

“I was asked by a friend if I had any debt and I said no even though I have medical debt. I was embarrassed.” -Millennial woman (27-42 years old)

“I didn’t want to let on how difficult of a financial situation we were in when both me and my husband were laid off around the same time so downplayed it and said we had enough in savings to live on, which was untrue.” -Woman age 59 or older

Overall, Women Are Confident Financial Decision Makers

Tight budgets, knowledge gaps, and uncomfortable conversations aside, the 2024 Her Money Mindset survey found that women are taking charge of their finances. 

More than half of all women (58%) told Investopedia and REAL SIMPLE that they feel somewhat or very confident in their ability to make good financial decisions, and that confidence increases with age and income.

Important

The 2024 Her Money Mindset Survey found 66% of women have made at least one financial decision they’re super proud of.

When comparing their financial know-how to friends and partners, 40% of women feel confirmed they know more than their friends, and 36% feel they know more than their partner and are able to make more responsible decisions. 

Ahead of a great wealth transfer that will put more wealth in women’s hands than ever before, women are directing this confidence into action and leading, or in some cases owning, financial decision-making for their household.

Our survey found 60% of all women make decisions about their finances independently, and the other 40% share financial decision-making with someone else. Half of the women surveyed are married or living with a significant other, and in that citation, women said they are talking about money with their partner, sharing finances, and sharing responsibilities, despite often earning less than their partner. 

Women are taking an active role in learning more about managing finances, too: 39% of women said they look for financial information at least monthly. That rate is even higher for millennials and younger women (48%). The preferred sources of education? Financial information websites, online searches, and talking to friends and family. 

Methodology

For the 2024 Her Money Mindset Survey, REAL SIMPLE and Investopedia surveyed 2,002 American women (aged 18+) from January 9th to 22nd, 2024. The survey was fielded online via a self-administered questionnaire to an opt-in panel of respondents from a market research vendor. 

Quotas were implemented in sampling using benchmarks from American Community Survey (ACS) from the U.S. Census Bureau for region, age groups, race/ethnicity, and household income. Respondents must have reported at least partially managing their own finances in order to qualify.

Reviewed by Somer Anderson
Fact checked by Jared Ecker

Unemployment “rises like a rocket and falls like a feather,” as two economic experts put it. That is, in a downturn, unemployment rises quickly but drops slowly. Let’s explore what happens to unemployment during a recession.

Key Takeaways

• Recession and unemployment go hand in hand and reinforce one another.
• The 2007-2009 recession has characteristics of common economic downturns as opposed to the relationship between unemployment and economic growth during the 2020 recession.
• Fiscal and monetary policies try to limit the impact of unemployment on recessions.
• Prompt, automatic aid for those who need it most tends to produce the most benefit.

Understanding Recessions

A recession is a significant and broad decline in the economy, usually lasting more than a few months. In the United States, the National Bureau of Economic Research (NBER) uses a number of indicators to determine when recessions start and end, including:

• The monthly nonfarm payrolls report and household employment survey
• Real personal income less transfers
• Real personal consumption expenditures
• Wholesale and retail sales
• Industrial production

Important

One rule of thumb is that if there are two consecutive quarters of negative gross domestic product (GDP) growth, then the economy is in recession. However, this method isn’t used by all analysts—take the 2022 non-recession, for example.

Unemployment During the 2007-2009 Recession

While unemployment is an important recession indicator, it’s also important to remember that unemployment usually peaks long after the recession has begun and can last well into the recovery. That’s because the NBER and other sources say a recession is over when the economic contraction hits bottom and starts to rebound, not when the recovery is complete.

For an example, the charts below show the change in unemployment and GDP growth during the Great Recession.

That recession began in December 2007 and ended in June 2009, according to the NBER. Yet in April 2008, five months into the recession, the U.S. unemployment rate was just 5%, up only slightly from 4.7% six months earlier. Unemployment continued to rise to hit 10% by October 2009, four months after the official end of the recession and seven months after the stock market hit bottom.

Unemployment During the 2020 Recession

During the much shorter two-month recession set off by the COVID-19 pandemic, unemployment climbed from just 3.5% in February 2020 to 14.7% in April 2020, the month when the recession ended. That was unusual: it was the first time in 70 years that unemployment associated with a recession peaked before the economy was well into recovery.

Why Unemployment Rises During a Recession

Because a recession is a slowdown in economic activity and labor is a key economic input, along with capital, it is logical that unemployment would rise as output (what companies make and sell) declines as companies making less and selling less need fewer employees.

The relationship between employment and output growth is consistent enough that there is an economic principle that describes it: Okun’s law, named after Arthur Okun, the economist who first documented it. A related rule of thumb says the economy must grow two percentage points faster than its potential growth rate to cut the unemployment rate by one percentage point.

The potential growth rate is an estimate of what GDP growth could be if labor and capital were fully used—that is, everyone who can work has a job and all money available to invest is invested. But because potential GDP is theoretical and not easily measured, there are a variety of ways to calculate it, and each way produces different results.

Thus, while Okun’s law is useful to understand the relationship between unemployment and economic growth, the law is not very useful in forming economic policy, since it is difficult to make accurate assessments.

The Extra Costs of Unemployment in a Recession

Unemployment is contagious. Initial layoffs when the recession starts cut demand as unemployed workers spend less, cutting demand further, which can in turn lead to more layoffs. The negative feedback loop eventually runs out of steam, but not before inflicting lasting damage on the economy and workers.

People who lose jobs during recessions, especially deep recessions, are more likely to become long-term unemployed and find it more difficult to reenter the labor market later. Among workers who lost their jobs during the Great Recession, only 35% to 40% were employed full-time by January 2010. Reemployment rates remained unusually low as late as 2013.

Another survey found that men lose an average of 1.4 years of earnings if laid off when the unemployment rate is below 6%, but they lose twice as much if the unemployment rate is above 8%. Beyond its immediate economic costs, long-term unemployment also damages public health and the economy’s long-term productive potential.

Policies That Limit Unemployment in Recessions

Governments around the world use fiscal and monetary policies to manage the highs and lows of the business cycle. This means that they usually spend more but also collect less in tax when the economy slumps as they try to boost aggregate demand to avoid even more unemployment that could worsen the downturn. A similar rationale leads central banks to cut interest rates and buy assets to stimulate the economy during downturns.

There are also many automatic stabilizers that kick in during economic downturns. These mechanisms do not require the government to make a policy change or pass new legislation. They include programs such as unemployment insurance and other transfer payments. Automatic stabilizers are especially valuable because they can quickly direct aid to the people who need it most and often spend it fastest, increasing its benefit to the economy.

Most controversial of all is targeted government relief for specific industries or companies, the sort of assistance also known as a bailout. Some critics object to public aid to for-profit companies on principle, while others argue that the relief is misguided and may not benefit the right companies.

In 2008–2009, the U.S. government spent nearly $80 billion to avert the bankruptcy of U.S. automakers. It did, however, later recoup 85% of that aid. Supporters note that the bailout saved hundreds of thousands of auto industry jobs and prevented a regional depression. Critics argue that it set a bad precedent and encouraged riskier business behavior by the industry.

Why Does Unemployment Rise in a Recession?

As economic activity slows in a recession, consumers cut spending. When that happens, there is less demand for the goods and services that companies sell, so companies manufacture less and may trim their service offerings. But making fewer products and offering fewer services also means companies need fewer employees, and layoffs often result. When people are laid off, they are forced to cut spending, which further decreases demand, which can lead to further layoffs. The cycle continues until the economy recovers.

Why Does Unemployment Tend to Fall Slowly After a Recession?

Companies are usually quick to cut costs when demand for their products and services declines, but they are generally more cautious about adding that cost back by hiring new employees even as the economy recovers. Also, a recession ends when the economy hits bottom, but employment tends to recover long after the economy is well into recovery.

How Has Unemployment Been Different in Recent Recessions?

Historically, unemployment improves long after the official end of the recession. This is because a recession ends when the economy hits bottom, and companies start to rehire only after the economy has started to recover. However, in the COVID-19 pandemic-induced recession, employment recovered more quickly than the economy, for the first time in 70 years.

The Bottom Line

Recession and unemployment go hand in hand: a spike in unemployment and its persistence are hallmarks of a recession, and joblessness, in turn, aggravates recessions. The short-term and long-term costs of unemployment have led governments to develop a range of policy measures aimed at curbing joblessness during downturns.  The most recent recession (in 2020) was different, as unemployment improved more quickly than in most economic cycles, recovering before economic growth did.

Reviewed by Charlene Rhinehart
Fact checked by Suzanne Kvilhaug

Companies that report losses are more difficult to value than those reporting consistent profits. Any metric that uses net income is nullified as an input when a company reports negative profits. Return on equity (ROE) is one such metric. However, not all companies with negative ROEs are bad investments. 

Key Takeaways

• Return on equity (ROE) is measured as net income divided by shareholders’ equity.
• When a company incurs a loss, the return on equity is negative.
• A negative ROE may occur if a company improves the business, such as through restructuring.
• New businesses, such as startups, typically have many years of losses before becoming profitable.

Components of ROE

• Net income after taxes over a period
• Shareholders’ equity at the start of the period
• Shareholders’ equity at the end of the period

Calculating Return on Equity

In the ROE formula, the numerator is net income or the bottom-line profits reported on a firm’s income statement. The denominator is equity, or, more specifically, shareholders’ equity. When net income is negative, ROE will also be negative.

For most firms, a “good” ROE will depend on the company’s industry and competitors and commonly cover their costs of capital. An industry will likely have a lower average ROE if it is highly competitive and requires substantial assets to generate revenues.

ROE = Net income / Average shareholders’ equity  

A company’s ROE can be analyzed by comparing it to its competitors or how it has changed over time.

Negative ROE Example

When analysts or investors only consider net income, a negative ROE may be misleading. In 2022, Hewlett-Packard (HPQ) reported many charges to restructure its business. The charges included headcount reductions and writing down goodwill after a botched acquisition, resulting in a negative net income of $12.7 billion, or negative $6.41 per share.

Reported ROE was equally dismal at -51%. However, free cash flow generation for the year was positive at $6.9 billion, or $3.48 per share. That’s quite a stark contrast from the net income figure and resulted in a much more favorable ROE level of 30%.

For astute investors, this could have indicated that HP wasn’t in a precarious position as its profit and ROE levels showed. Indeed, the next year net income returned to a positive $5.1 billion, or $2.62 per share. Free cash flow improved as well to $8.4 billion, or $4.31 per share. The stock then rallied as investors started to realize that HP wasn’t as bad an investment as its negative ROE indicated.   

What Can Investors Use to Analyze a Company With Negative Net Income?

A firm may report negative net income, but it doesn’t always mean it is a bad investment. Free cash flow is another form of profitability and can be measured instead of net income.

What If a Company Consistently Loses Money Annually?

Investors should be wary of an organization that consistently loses money without a good reason. In that case, negative returns on shareholders’ equity may be a warning sign that the company is not healthy. For many companies, something as simple as increased competition can deplete returns on equity.

Why Do Startups Commonly Show a Negative ROE?

Initial public offerings (IPOs) or startup companies may lose money in their early days. Therefore, if investors only looked at the negative return on shareholder equity, no one would ever invest in a new business. This type of attitude would prevent investors from buying into great companies early on at relatively low prices. Startups may show negative shareholders’ equity for years, rendering returns on equity meaningless for some time. Even once a company starts making money and pays down accumulated debts on its balance sheet, replacing them with retained earnings, investors can still expect losses.

The Bottom Line

Subscribing to the traditional definition of ROE can mislead investors. Firms that chronically report negative net income, but have healthier free cash flow levels, might translate into a higher ROE than investors might expect. New businesses typically have many years of losses before becoming profitable.

Reviewed by Amy Drury

What Is Compound Interest

Compound interest is interest that’s calculated both on the initial principal of a deposit or loan, and on all accumulated interest.

Compound interest is a tremendous advantage for savers and investors. For borrowers, not so much. That’s because savers and investors benefit from the powerful growth in the value of their financial accounts that compounding interest provides over time.

For borrowers, that compounding interest and growth in balance benefits the lender and means having to pay more to get out of debt.

Read on to learn more about compound interest and how to calculate it using Excel.

Key Takeaways

• Compound interest is calculated on the amounts of principal (or initial deposit) and interest in your account.
• As interest increases your account value, subsequent compound interest calculations apply to larger amounts.
• Compound interest can be an advantage if you’re saving money or a disadvantage if you’re borrowing it.
• Excel can simplify your compound interest calculations.

Understanding Compound Interest

Compound Interest Works In Your Favor

Let’s say that you have an account with a deposit of $100 that earns a 10% annual compounded interest rate. That $100 grows to $110 after the first year:

$100 x .10 = $10

$100 + $10 = $110 new balance

The account value then grows to $121 when interest is calculated after the second year. 

$110 x .10 = $11

$110 + $11 = $121 new balance

The reason the second year’s gain is $11 instead of $10 is because the 10% rate was applied to a larger account balance.

As you can see, the 10% interest applied to $100 created the new balance of $110. After year two, the 10% was applied to that new balance of $110, for a third new balance $121. At the end of the third year, the 10% will be applied to $121 and a larger new balance will be the result.

Because compound interest is working for you by increasing the value of your investment, you’ll want to keep your money invested for as long as possible.

Compound Interest Works Against You

Let’s say that you borrowed $100 (the principal amount) at a compound interest rate of 10% that’s applied annually. Using the same calculation above, after one year you’ll have $100 in principal and $10 in interest, for a total amount owed by you of $110. 

$100 x .10 = $10

$100 + $10 = $110 new balance

In year two, the 10% interest rate is applied to both the principal of $100, resulting in $10 of interest, and the accumulated interest of $10, resulting in $1 of interest. This results in a total of $11 in interest gained that year, which is $21 for both years ($10 after year one + $11 after year two).

$100 x .10 = $10

$10 x .10 = $1

$10 + $1 = $11 total new interest

$110 + $11 = $121 new balance 

Because compound interest is working against you by increasing the amount you must pay back to the lender, you’ll want to pay off your debt as soon as possible.

Formula for Compound Interest

The compound interest formula is similar to the Compounded Annual Growth Rate (CAGR). For CAGR, you are computing a rate that links the return over a number of periods. For compound interest, you most likely know the rate already and are just calculating what the future value of the return might be. 

For the formula for compound interest, just algebraically rearrange the formula for CAGR. You need the:

• Beginning value
• Interest rate
• Number of periods in years

The interest rate and number of periods need to be expressed in annual terms, since the length is presumed to be in years. From there you can solve for the future value. The equation reads:

$begin{aligned}&text{Beginning Value}\&timesleft(1+left(frac{text{interest rate}}{text{NCPPY}}right)right)^{(text{years} times text{NCPPY)} = text{Future Value}}\&textbf{where:}\&NCPPY=text{number of compounding periods per year}end{aligned}$​Beginning Value×(1+(NCPPYinterest rate​))(years × NCPPY) = Future Valuewhere:NCPPY=number of compounding periods per year​

This formula looks more complex than it really is, because of the requirement to express it in annual terms. 

Keep in mind, if it’s an annual rate, then the number of compounding periods per year is one, which means you’re dividing the interest rate by one and multiplying the years by one. If compounding occurs quarterly, you would divide the rate by four, and multiply the years by four. 

Calculating Compound Interest in Excel

Financial modeling best practices require calculations to be transparent and easily auditable. The trouble with piling all of the calculations into a formula is that you can’t easily see what numbers go where, or what numbers are user inputs or hard-coded. 

There are three ways to set this up in Excel. The most easy to audit and understand is to have all the data in one table, then break out the calculations line by line. Conversely, you could calculate the whole equation in one cell to arrive at just the final value figure. All three ways are detailed below:

Does Interest Always Compound Annually?

No, it can compound at other intervals including monthly, quarterly, and semi-annually. Some investment accounts, such as money market accounts, compound interest daily and report it monthly. The more frequent the interest calculation, the greater amount of money that results.

Why Does Compound Interest Matter?

It matters because it can increase financial values for account balances more quickly than simple interest. These increasing balances may be great for savers and investors who want to see their money grow. But for borrowers, they can be a source of worry and financial hardship if they aren’t able to pay them down or completely off as quickly as they can.

Who Sets the Compound Interest?

That can depend. A financial institution will set the rate and interval for different accounts that it offers savers, investors, and borrowers. If you’re lending money to a friend for a business opportunity, you might set a compound interest rate that will be charged annually (or more frequently) until the loan is repaid.

The Bottom Line

Excel can be a helpful and powerful partner when you need to calculate compound interest amounts for different purposes, such as loans and investments. It’s especially convenient when frequent intervals are involved over multiple years and accuracy counts.

How the Oracle of Omaha Profits When Others Panic

Since 1965, shares of Warren Buffett’s conglomerate, Berkshire Hathaway (BRK.B), have delivered a compounded annual return of 19.9%—almost double that of the S&P 500 over the same period. Unlike many of Wall Street’s famous money managers, Buffett has thrived during market crashes by following a straightforward approach any investor can follow: buying quality businesses at discounted prices when others are selling in a panic.

Below, we break down the principles that have kept Buffett successful through several market crashes.

What You Need to Know

• Buffett turns market crashes into opportunities by following his own advice to “be fearful when others are greedy and greedy when others are fearful.”
• Focusing on strong business fundamentals rather than short-term price movements has been central to Buffett’s success, as demonstrated by his long-term holdings in companies like Coca-Cola Co. (KO) and American Express Company (AXP).

Principle 1: Stay Calm and Avoid Panic Selling

Buffett often emphasizes that “the stock market is designed to transfer money from the
active to the patient.” He cautions against emotional decision-making during market downturns, noting that selling out of fear often leads to significant losses.

A look at the S&P 500 Index’s long-term performance proves his point—despite countless sell-offs, recessions, and geopolitical crises, $100 invested in 1928 would be worth over $982k today.

Principle 2:

Among Buffett’s best-known and most-repeated quotes is, “Be fearful when others are greedy and be greedy only when others are fearful.” This isn’t just clever wordplay—it’s the backbone of his wealth-building strategy.

While most investors run for the exits during market crashes, Buffett reaches for his checkbook. During the 2008 financial crisis, when banking stocks were in free fall and many predicted the collapse of the financial system, Buffett invested $5 billion in Goldman Sachs Group, Inc. (GS). The deal included preferred shares with a 10% dividend yield and warrants to purchase common stock, ultimately netting Berkshire Hathaway over $3 billion in profit.

Principle 3: Focus on Business Fundamentals

Buffett has a simple test for market downturns: Does a 30% drop in share price change how many Cokes people will drink next year? Does it affect how many people will use their American Express cards? If the answer is no, then the intrinsic value remains intact despite the market’s temporary opinion.

Berkshire Hathaway’s investment in the Washington Post illustrates this approach. In 1973, during a severe market decline, Buffett purchased shares at just 25% of what he calculated as their intrinsic value. The price fell even further afterward, but Buffett wasn’t deterred—he understood the fundamental strength of the business wasn’t reflected in its stock price. His patience paid off: Berkshire’s $10.6 million investment ballooned to over $200 million by 1985, a return of almost 1,900%. This wasn’t investment wizardry—it was Buffett recognizing that fearful markets often misprice great businesses. 

Principle 4: Don’t Time the Market

Buffett discourages trying to predict market movements, calling it a fool’s game, and instead holds for the (very) long term. Once again putting his money where his mouth is, Buffett has held shares of
Coca-Cola for 36 years and has held American Express shares since the 1960s.

Principle 5: Keep Cash Reserves for Opportunities

While most financial advisors recommend staying fully invested, Buffett views cash differently—not as something that doesn’t earn interest or dividends sitting in a bank account, but as “financial ammunition” for when rare prospects appear.

Berkshire’s massive cash position—often criticized during bull markets—transforms from a liability into Buffett’s secret weapon during crashes. In 2010, after deploying billions during the financial crisis, Buffett formalized this strategy in his shareholder letter, pledging to maintain at least $10 billion in cash reserves (though typically keeping closer to $20 billion). This wasn’t excessive caution but strategic preparation for the next inevitable market panic.

In the mid-2020s, with the markets on edge, Buffett is again holding a record cash stockpile.

The Bottom Line

Buffett’s philosophy underscores the importance of staying rational, focusing on fundamentals, and seeing market declines as opportunities rather than setbacks.

Here are the types of stocks that typically do well—and the types that typically don’t—during market downturns

Reviewed by Michael J Boyle
Fact checked by Timothy Li

During a recession, the worst-performing assets are highly leveraged, cyclical, and speculative. Companies that fall into any of these categories can be risky for investors because of the potential that they could go bankrupt.

Conversely, investors who want to thrive during a recession will invest in high-quality companies that have strong balance sheets, low debt, and good cash flow, and are in industries that historically do well during tough economic times.

Key Takeaways

• During a recession, most investors should avoid investing in companies that are highly leveraged, cyclical, or speculative, as these companies pose the biggest risk of doing poorly during tough economic times.
• A better recession strategy is to invest in well-managed companies that have low debt, good cash flow, and strong balance sheets.
• Countercyclical stocks do well in a recession and experience price appreciation despite the prevailing economic headwinds.
• Some industries are considered more recession-resistant than others, such as utilities, consumer staples, and discount retailers.

Types of Stocks with the Biggest Recession Risk

Knowing which assets to avoid investing in can be just as important as knowing which companies make good investments. The companies and assets with the biggest risk during a recession are those that are highly leveraged, cyclical, or speculative.

Highly Leveraged Companies

During a recession, most investors would be wise to avoid highly leveraged companies that have huge debt loads on their balance sheets. These companies often suffer under the burden of higher-than-average interest payments that lead to an unsustainable debt-to-equity (DE) ratio.

While these companies struggle to make their debt payments, they are also faced with a decrease in revenue brought about by the recession. The likelihood of bankruptcy (or at the very least a precipitous drop in shareholder value) is higher for such companies than those with lower debt loads.

Credit Crunch

The more leveraged a company is, the more vulnerable it can be to tightening credit conditions when a recession hits.

Cyclical Stocks

Cyclical stocks are often tied to employment and consumer confidence, which often decline in a recession. Cyclical stocks tend to do well during boom times, when consumers have more discretionary income to spend on nonessential or luxury items. Examples would be companies that manufacture high-end cars, furniture, or clothing.

When the economy falters, however, consumers typically cut back their spending on these discretionary expenses. They reduce spending on things like travel, restaurants, and leisure services. Because of this, cyclical stocks in these industries tend to suffer, making them less attractive investments for investors during a recession.

Cyclical Assets

Stocks that move in the same direction as the underlying economy are at risk when the economy turns down.

Speculative Stocks

Speculative stocks are valued based on optimism among the shareholder base. This optimism is tested during recessions, and these assets are typically the worst performers in a recession.

Speculative stocks have not yet proven their value and are often seen as under-the-radar opportunities by investors looking to get in on the ground floor of the next big investment opportunity. These high-risk stocks often fall the fastest during a recession as investors pull their money from the market and rush toward safe-haven investments that limit their exposure during market turbulence.

Speculation

Speculative asset prices are often fueled by the market bubbles that form during an economic boom—and go bust when the bubbles pop.

Types of Stocks that Often Do Well During Recessions

While it might be tempting to ride out a recession with no exposure to stocks, investors may find themselves missing out on significant opportunities if they do so. Historically, there are companies that do well during economic downturns. Investors might consider developing a strategy based on countercyclical stocks with strong balance sheets in recession-resistant industries.

Strong Balance Sheets

A good investment strategy during a recession is to look for companies that are maintaining strong balance sheets or steady business models despite the economic headwinds. Some examples of these types of companies include utilities, basic consumer goods conglomerates, and defense stocks. In anticipation of weakening economic conditions, investors often add exposure to these groups in their portfolios.

By studying a company’s financial reports, you can determine if they have low debt, healthy cash flows, and are generating a profit. These are all factors to consider before making an investment.

Strong Balance Sheets

Companies with strong balance sheets are less vulnerable to tightening credit conditions and have an easier time managing the debt that they do have.

Recession-Resistant Industries

While it might seem surprising, some industries perform quite well during recessions. Investors looking for an investment strategy during market downturns often add stocks from some of these recession-resistant industries to their portfolios.

Countercyclical stocks like these tend to do well during recessions because their demand tends to increase when incomes fall or when economic uncertainty prevails. The stock price for countercyclical stocks generally moves in the opposite direction of the prevailing economic trend. During a recession, these stocks increase in value. During an expansion, they decrease.

These outperformers generally include companies in the following industries: consumer staples, grocery stores, discount stores, firearm and ammunition makers, alcohol manufacturers, cosmetics, and funeral services.

Consumer Demand

Many of these companies see an increase in demand when consumers cut back on more expensive goods or brands or seek relief and security from fear and uncertainty.

Investing During the Recovery

Once the economy is moving from a recession to a recovery, investors should adjust their strategies. This environment is marked by low interest rates and rising growth.

The best performers are those highly leveraged, cyclical, and speculative companies that survived the recession. As economic conditions normalize, they are the first to bounce back and benefit from increasing enthusiasm and optimism as the recovery takes hold. Countercyclical stocks tend not to do well in this environment. Instead, they encounter selling pressure as investors move into more growth-oriented assets.

Risky, leveraged, speculative investments benefit from the rise in investor sentiment and the easy money conditions that characterize the boom phase of the economy.

Is It Risky to Invest When a Recession is Nearing?

When an economy is nearing a recession, chances are that markets will fall as profits shrink and growth turns negative. During a recession, stock investors must use extra caution, as there is a good chance that they will see price depreciation of their investments. That said, timing a recession is difficult to do, and selling into a falling market may be a bad choice. Most experts agree that one should stay the course and maintain a long-term outlook even in the face of a recession, and use it as an opportunity to buy stocks on sale.

Which Assets Tend to Fare Best in a Recession?

Not all assets are impacted the same way by a recession. As spending shifts to basics, consumer staples, utilities, and other defensive stocks may fare better. Companies with strong balance sheets will also be able to weather a temporary decline in profits more than a high-spending growth stock. Outside of stocks, bonds may rise and interest rates are cut in response to an economic contraction.

Which Stocks Are Hurt the Most by a Recession?

Growth stocks with high debt loads are often the most vulnerable to a recession. This is because they may find it hard to raise new capital as the economy contracts, while their profits can be eroded by lower consumer spending. Speculative stocks with shaky fundamentals are among the most risky as a recession hits.

The Bottom Line

Every recession eventually turns around and goes up over the long run. By developing a strategy based on countercyclical stocks with strong balance sheets in recession-resistant industries, investors can get in on one of the biggest market booms and avoid the turbulence that often results when the economy weakens.

Long-term investors willing to stand through these volatile times eventually will be able to reap the rewards. They may also be able to sell quickly and buy more profitable assets when the bear market is in full force and position themselves ahead of the recovery for even bigger gains when the market improves.

Reviewed by Charlene Rhinehart
Fact checked by Vikki Velasquez

Par Value vs. Market Value: An Overview

There are different types of value in the financial world. Two of the most common are par value and market value. Both represent an asset’s monetary worth. But they are inherently different.

A par value is the face or nominal value of an asset. The issuing entity assigns a par value to it. When shares of stocks and bonds were printed on paper, their par values were printed on the faces of the shares. A market value is the actual price that a financial instrument is worth at any given time. It fluctuates with market swings as investors buy and sell shares.

Key Takeaways

• A par value and market value are used to describe the monetary or assessed worth of an asset.
• Par values represent the face value or original price of an asset.
• An asset’s market value indicates how much someone is willing to pay for it at a specific time.
• Par values are important for bond investors because they represent the principal amount.
• Market values are common for stocks, whose prices change throughout a trading session.

Par Value

The term par value is the stated value of an asset—typically of a bond or stock. It is interchangeable with face value or nominal value, or the written value on a bond or stock certificate. Put simply, it is the original value of the asset.

Par Values for Bonds

Most individual investors buy bonds because they are considered to be safe-haven investments. When a bond is issued, its par value represents its worth when it matures. The yield is paid in regular installments, providing income until the bond matures. The investor then gets the original investment back. In other words, they intend to hold on to the bond until it matures.

Let’s assume that Company X issues bonds with a par value of $100 with a maturity date of one year. Once the year is up, the bondholder is entitled to collect $100 from the issuer in addition to whatever interest payments the bond yields.

A bond can be purchased for more or less than its par value, depending on prevailing market sentiment about the security. When it reaches its maturity date, the bondholder is paid the par value regardless of the purchase price. Thus, a bond with a par value of $100 purchased for $80 in the secondary market will yield a 25% return at maturity.

Par Values for Stocks

The par value for company shares is typically listed on the stock certificate. This is normally stated in the corporate charter. Unlike bonds, a stock share’s face value is unrelated to what is stated in the charter. Shares frequently have a par value near zero because most new companies are established with a limited number of authorized shares.

This means the market value is nearly always higher than par. Rather than looking to purchase shares below par value, investors make money on the changing value of a stock over time. This is based on company performance and investor sentiment.

Note

Bonds are not necessarily issued at their par value. They could also be issued at a premium or at a discount depending on factors like the level of interest rates in the economy.

Market Value

As noted above, the term market value refers to the amount that an asset is worth at any given time. Put simply, it’s the amount that people will pay for an asset on the open market. For instance, an asset may cost $10 one year ago but may fetch $20 a year later. Market value tends to fluctuate based on investor sentiment, the economy, market conditions, or a combination of any of these.

Market Values for Bonds

The market value of bonds is determined by the buying and selling activity of investors in the open market. This value matters for bonds only if it is traded in the secondary market rather than being held.

Before its maturity date, the market value of the bond fluctuates in the secondary market, as bond traders chase issues that offer a better return. However, when the bond reaches its maturity date, its market value will be the same as its par value.

Market Value for Stocks

The market value of stocks is what matters—not their par value. Most stocks are assigned a par value when they are issued. The par value assigned is generally a minimal amount, such as one penny. This avoids any potential legal liability if the stock drops below its par value.

Some stocks are issued with no par, depending on state laws. But, it’s the stock market that determines the stock’s real value, which continually shifts as shares are bought and sold throughout the trading session.

Par Value, Market Value, and Stockholders’ Equity

Stockholders’ equity is the book value of a company. It is calculated as a company’s total assets minus its total liabilities. It can also be determined as the value of shares held or retained by the company and the earnings the company keeps minus Treasury shares.

This figure is recorded on a company’s balance sheet. But, it does not accurately reflect the company’s market value. That’s because shareholders’ equity includes paid-in capital retained along with the par value of common and preferred stock. The values signify the par value of a stock at the time of the transaction—not their fair market values (FMV).

The value of common stock is calculated by multiplying the number of shares the company issues by the par value per share. To determine the value of the preferred stock, multiply the number of preferred shares issued by the par value per share.

Note

The par value of a bond is relevant to the average investor, while the par value of a stock is something of an anachronism. Par value for a share refers to the nominal stock value stated in the corporate charter. Shares can have no par value or very low par value, such as a fraction of one cent per share.

Par Value vs. Market Value Example

Apple (AAPL) had total assets of $364.98 billion and $308.03 billion of total liabilities at the end of fiscal year 2024. The company’s resulting total stockholders’ equity was $56.95 billion. However, its equity par value was roughly $83,28 billion. This is based on a par value of $0.00001 with 50.4 million authorized shares, over 15.55 million shares issued, and more than 15.94 million shares outstanding.

Why Is It Called Par Value?

Par is said to be short for parity, which refers to the condition where two (or more) things are equal to each other. A bond trading at its stated face value is trading at par. Par may also refer to scorekeeping in golf, where par is the number of strokes a player should normally require for a particular hole or course.

What’s the Difference Between a Bond’s Par Value and Its Face Value?

Nothing, the two terms are interchangeable. The par value for a bond is typically $100 or $1,000 because these are the usual denominations in which they are issued.

Is Par Value the Same as Book Value?

No. Book value is the net value of a firm’s assets found on its balance sheet, and it is roughly equal to the total amount all shareholders would get if they liquidated the company. Book value will often be greater than par value, but lower than market value.

Is Par Value More Important Than Market Value?

This depends on the type of asset you’re talking about. The par value matters for long-term bondholders because it is the bond’s face value or the amount that will be repaid as principal when the bond matures. This is regardless of what the market price is at any point in time.

The market value, on the other hand, is what matters the most for stock traders. This is the current price of shares and reflects how much people are willing to pay at a specific time.

What Are the Market Value and Par Value Methods for Treasury Stock?

Treasury stock refers to previously outstanding stock that is bought back from stockholders by the issuing company. There are two methods to record a firm’s treasury stock: the market value method and the par value method.

The market value method uses the market value paid by the company during a repurchase of shares and ignores their par value. In this case, the cost of the treasury stock is included within the stockholders’ equity portion of the balance sheet.

Under the par value method, the treasury stock account is debited when shares are repurchased. This decreases the total shareholder’s equity in the amount of the par value of the shares being repurchased. It is common for stocks to have a minimum par value, such as $1, but sell and be repurchased for much more.

The Bottom Line

As an investor, it’s important to understand the difference between par and market values. The term par value refers to an asset’s face value or the (original) price when it is issued while the market value is the price at which investors are willing to acquire an asset at any given time. Par values are important for people who invest in bonds because they represent the principal amount that is repaid to them at maturity in addition to any interest. Market values are used for stocks because their prices fluctuate during the trading day.

Reviewed by Eric Estevez
Fact checked by Vikki Velasquez

A restaurant can measure success through customer return visits and reviews from local media. Seven key ratios can help measure financial profits and ongoing costs and revenues. Keeping track of them allows owners to make adjustments to maintain the level of profitability the business needs to thrive.

Key Takeaways

• Financial ratios help measure how efficiently a restaurant is operating.
• Food costs, inventory control, and floor space can be evaluated.
• Restaurant owners and investors use financial data to identify where changes are needed.

Prime Costs to Total Costs

In the restaurant industry, prime costs include food, beverages, management, hourly staff, and benefits expenses. A rule of thumb is that the prime costs of a restaurant should equal 60% or less of the restaurant’s total sales figures.

The ratio is higher for a company that owns the structure in which it operates and does not have rent or mortgage payments to pay. Prime costs higher than these percentages may indicate that some costs can be trimmed.

Specific Food Cost to Total Cost

Food cost to total cost is used to measure the real expenses of specific products on the menu. This metric is especially useful if changes to the menu are planned. The food cost that is tracked can be for a specific menu item or a group of items. This metric is useful in determining if specific menu items should be discontinued.

For example, a restaurant may find that it is spending 20% of its total food costs on buying the ingredients for hamburgers, even though only 5% of its sales are of hamburgers. Or, 40% of food costs may be spent on seafood, even though fish is not the menu item the restaurant is known for.

Inventory Turnover

Restaurants depend on perishable goods, making it especially important that their managers maintain appropriate inventory. The inventory turnover ratio is calculated by dividing net sales by the average cost of inventory.

A metric materially higher than industry averages may suggest that inventory purchases are insufficient, that quantity discounts are not being exploited, or that the business is risking shortages of supplies. A calculation substantially lower than average might mean that too much food is being purchased, that business has slowed, or that food quality is declining due to a lack of fresh products.

Important

The U.S. Department of Agriculture estimates that 30% of the food supply is lost or wasted at the retail and consumer levels.

Sales Per Square Foot

Restaurants determine how efficiently floor space is being used by analyzing the sales per square foot ratio. This financial metric divides the total sales for a period by the total square footage of the restaurant location.

This number may lead to improvements in the layout of the restaurant and the use of the available space. It may help identify ways to expand seating or the need to replace bulky or underused equipment.

Revenue Per Seat

To calculate revenue per seat, the total dollar amount of revenue earned on a given night is divided by the total number of available seats in the restaurant.

This metric is most useful to management when it plans to reduce or expand the number of available seats. It also can be used to analyze the real benefits of renovation costs that would be incurred.

Food/Beverage Expenses to Sales

The food/beverage expense-to-sales ratio gauges how well the company is profiting on each item served. It can be broken down to a specific menu item, such as salmon, a food group, such as seafood, or as an aggregate, such as all food served.

By using this metric for a menu item, management and investors can understand the profit margin per item and whether changes are necessary for pricing or the menu.

Restaurants can use the Food & Drug Administration’s (FDA) Food Traceability Rule to quickly identify, and remove potentially contaminated foods from distribution.

Current Ratio

The current ratio is calculated by dividing assets on hand by liabilities incurred. This metric measures the liquidity of an organization.

A current ratio greater than one indicates that a company can pay its short-term debts using only short-term assets if liquidation is necessary. It is an indication of the company’s ability to pay for items in the short term, including food, beverages, and staff wages.

How Do Restaurants Measure Inventory?

While many restaurants may rely on traditional counts or tally sheets, most restaurants use cloud-based software programs for inventory management. They give owners real-time tracking integrated into the point-of-sale system and can break down the costs of individual recipes by ingredients. They also allow for ordering and purchasing links.

How Do Food Manufacturers Determine Food Quality Dates?

Restaurants and retail stores rely on quality dates to determine the shelf life of food products. Dates depend on factors such as the length of time and the temperature at which a food is held during distribution and offered for sale, and the type of food and its packaging.

What Do Sales Reports Tell Restaurant Owners?

Food and beverage sales reports can be generated daily, weekly, or monthly. They can detail sales by menu item and per employee.

The Bottom Line

Financial data helps restaurant owners zero in on details that affect profitability. Analyzing sales, inventory, and cost information allows restauranteurs to address low-profit areas quickly and plan for future investment.