How to Use This Dictionary
This is a reference guide. Each KPI includes the formula, what it measures, how to interpret it, and the most common mistakes in calculation. Keep it bookmarked.
Profitability Metrics
Gross Margin (%) Formula: (Revenue - COGS) / Revenue x 100
What it measures: The percentage of revenue retained after direct costs. It reflects pricing power, input cost management, and product mix.
Interpretation: Higher is better. Declining gross margin with stable revenue suggests input cost inflation or pricing concessions. Increasing gross margin with declining revenue may indicate the company is shedding low-margin business.
Common mistake: Including SG&A or depreciation in COGS. Gross margin should reflect only direct costs of production or service delivery.
EBITDA Margin (%) Formula: EBITDA / Revenue x 100
What it measures: Operating profitability before capital structure, tax, and non-cash charges. The standard profitability metric in PE.
Interpretation: Compare to industry benchmarks. Manufacturing: 10-20%. Business services: 15-25%. Technology: 20-40%. A margin below the peer median suggests either a pricing problem, a cost structure problem, or a scale problem.
Common mistake: Using adjusted EBITDA without disclosing add-backs. Always specify whether the margin is reported or adjusted, and what the add-backs are.
Net Margin (%) Formula: Net Income / Revenue x 100
What it measures: Bottom-line profitability after all costs, including interest, taxes, depreciation, and amortization.
Interpretation: Less useful than EBITDA margin for PE comparisons because it includes capital structure effects. However, persistent negative net margins indicate the business may not be generating sufficient cash to service its obligations.
Working Capital Metrics
Days Sales Outstanding (DSO) Formula: (Accounts Receivable / Revenue) x Days in Period
What it measures: The average number of days to collect payment from customers.
Interpretation: Lower is better. DSO above the peer 75th percentile for two consecutive periods is a warning sign. Rising DSO with stable revenue suggests deteriorating collections discipline or customer financial stress.
Common mistake: Using annual revenue instead of annualized period revenue. For a monthly calculation, use monthly revenue x 30 (or the actual days in the month).
Days Inventory Outstanding (DIO) Formula: (Inventory / COGS) x Days in Period
What it measures: The average number of days of inventory on hand.
Interpretation: Lower is better, but context matters. Manufacturing companies carry more inventory than service businesses. A DIO significantly above the peer median suggests excess or obsolete inventory, poor demand planning, or defensive overstocking.
Days Payable Outstanding (DPO) Formula: (Accounts Payable / COGS) x Days in Period
What it measures: The average number of days to pay suppliers.
Interpretation: Higher is better for cash flow, but stretching payables beyond terms damages supplier relationships. Optimal DPO matches or slightly exceeds contractual payment terms.
Cash Conversion Cycle (CCC) Formula: DSO + DIO - DPO
What it measures: The total number of days between paying for inputs and collecting from customers. The single most important working capital metric.
Interpretation: Lower is better. The gap between a company's CCC and the peer median, multiplied by daily revenue, is the working capital opportunity in dollar terms.
Liquidity Metrics
Current Ratio Formula: Total Current Assets / Total Current Liabilities
What it measures: The company's ability to meet short-term obligations with short-term assets.
Interpretation: Above 1.5x is healthy. Between 1.0-1.5x warrants monitoring. Below 1.0x is a liquidity warning. However, a very high current ratio (above 3.0x) may indicate inefficient use of capital.
Quick Ratio Formula: (Current Assets - Inventory) / Current Liabilities
What it measures: Same as current ratio but excludes inventory, which may not be quickly convertible to cash.
Interpretation: Above 1.0x is healthy. Below 1.0x means the company cannot cover current liabilities without selling inventory or drawing on credit facilities.
Leverage Metrics
Net Debt / EBITDA Formula: (Total Debt - Cash) / EBITDA
What it measures: The number of years of EBITDA required to repay net debt. The primary leverage metric in PE.
Interpretation: Below 3.0x is comfortable. 3.0-4.5x is typical for leveraged buyouts. Above 5.0x is elevated and requires close monitoring. Above 6.0x is often covenant-triggering.
Interest Coverage Ratio Formula: EBITDA / Interest Expense
What it measures: The company's ability to service its debt from operating earnings.
Interpretation: Above 3.0x is comfortable. Between 2.0-3.0x is tight. Below 2.0x is a warning sign. Below 1.5x means the company may struggle to meet interest payments from operations.
Growth Metrics
Revenue Growth (YoY) Formula: (Current Period Revenue - Prior Year Period Revenue) / Prior Year Period Revenue x 100
What it measures: Top-line growth rate.
Interpretation: Compare to industry benchmarks and the investment thesis. Revenue growth above 15% YoY creates "growth-stage pressure" on working capital — expect DSO and inventory to increase as the business scales. This is normal and should not be penalized in health scoring.
FCF Conversion Formula: Free Cash Flow / EBITDA x 100
What it measures: The percentage of EBITDA that converts to actual free cash flow. Healthy range: 60-80%.
Interpretation: Below 50% consistently suggests high capex requirements, working capital absorption, or EBITDA add-backs that do not reflect cash reality. Above 80% is excellent and suggests efficient capital deployment.
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