Financial Statements are prepared to know the profitability and financial position of the business in the market. These financial statements are then analysed with the help of different tools and methods. Ratio Analysis is one of the methods to analyse financial statements. The relationship between various financial factors of a business is defined through ratio analysis.
Accounting Ratios are broadly classified into 4 categories:
1. Liquidity Ratios
2. Solvency Ratios
3. Activity or Turnover Ratios
4. Profitability or Income Ratios
1. Liquidity Ratios:
The short-term financial position of an enterprise is assessed by liquidity ratios. ‘Liquidity’ refers to the firm’s ability to meet its current liabilities. Liquidity ratios indicate the firm’s ability to meet its current obligations out of the current resources.
Liquidity ratios include:
1. Current Ratio or Working Capital Ratio:
2. Quick Ratio or Acid Test Ratio or Liquid Ratio:
2. Solvency Ratios:
The firm’s ability to meet its long-term liabilities at the time of maturity is computed by solvency ratios.
Solvency ratios include:
or
2. Total Assets to Debt Ratio:
or
4. Interest Coverage Ratio:
3. Activity Ratios:
Activity ratios indicate how efficiently the Working Capital and Inventory are being used to obtain revenue from operations. It indicates the speed or number of times the capital employed has been rotated in the process of doing business.
Activity Ratios include:
1. Inventory Turnover Ratio or Stock Turnover Ratio:
2. Debtors or Receivables Turnover Ratio:
3. Creditors or Payables Turnover Ratio:
4. Working Capital Turnover Ratio:
4. Profitability Ratios:
The efficiency of any business is measured by the profit earned by the company. Profitability ratios measure the various aspects of the profitability of a company.
Profitability Ratios include:
A. General Profitability Ratios:
2. Operating Ratio:
4. Net Profit Ratio:
B. Overall Profitability Ratios:
1. Return on Investment: