CLASSIFICATON OF RATIO
Accounting ratios are generally classified as follows :
(1) Traditional classification
(2) Functional classification
(A) Traditional Classification:~
The ratios are grouped into three categories on the basis of the statements from which the figures are taken for computing the ratios. It is well known traditional classification and has been so grouped since the advent of the ratio analysis. The ratios according to this classification are :
(1) Revenue Statement Ratios :
These are ratios computed on the basis of items taken from revenue statement i.e. Profit and Loss Account. E.g. Net profit ratio is computed by dividing Net profit by sales. Here both net profit and sales are items appearing in Profit and Loss Account.
(2) Balance Sheet Ratios :
When two items or groups of items appearing in the balance sheet are compared the ratio so obtained is a balance sheet ratio. E.g. A ratio establishing relationship between current assets and current liabilities is a balance sheet ratio.
(3) Composite Ratios :
A ratio showing the relationship between one items taken from balance sheet and another taken from profit and loss account is a composite ratio or a combined ratio known as balance sheet and revenue statement ratio. A return on capital employed shows the proportion of net profit to capital employed and it is a composite ratio.
(B) Functional Classification:~
Ratios are also grouped in accordance with certain tests. On this basis there are four categories of ratios.
(1) Liquidity Ratios:
These ratios indicate the position of liquidity. They are computed to ascertain whether the company is capable of meeting its short-term obligations from its short term resources. For example, current ratio shows the capacity of a firm to meet its current liabilities as and when they mature. E.g.
(a) Current ratio
(b) Liquidity ratio
(c) Acid-test ratio
(2) Profitability Ratios:
A number of ratios are designed to indicate the profitability of the business and are grouped into the category of profitability ratios. For example, Return on capital employed is an example of profit ratio. E.g.
(a) Gross profit ratio
(b) Net profit ratio
(c) Expenses ratio
(d) Operating ratio
(e) Return on capital employed ratio
(f) Return on shareholders funds
(g) Debt service coverage ratio
(3) Leverage Ratios:
The composition of capital of business and the proportion of owners` capital and capital provided by outsiders are reflected by leverage ratios. For example, gearing ratio showing the relationship between the preference capital and ordinary capital is a leverage ratio. E.g.
(a) Proprietary ratio
(b) Debt-Equity ratio
(c) Gearing ratio
(d) Fixed capital- Fixed assets ratio
(4) Activity or Efficiency Ratios:
These are the ratios showing the effectiveness with the resources if the business are employed. It signifies the efficiency of the management. For example, stock turnover is an activity ratio, showing the number of times the average stock turnover turned over during the year. E.g.
(a) Debtors ratio or turnover
(b) Creditors ratio or turnover
(c) Total assets turnover
(d) Fixed assets turnover
Accounting ratios are generally classified as follows :
(1) Traditional classification
(2) Functional classification
(A) Traditional Classification:~
The ratios are grouped into three categories on the basis of the statements from which the figures are taken for computing the ratios. It is well known traditional classification and has been so grouped since the advent of the ratio analysis. The ratios according to this classification are :
(1) Revenue Statement Ratios :
These are ratios computed on the basis of items taken from revenue statement i.e. Profit and Loss Account. E.g. Net profit ratio is computed by dividing Net profit by sales. Here both net profit and sales are items appearing in Profit and Loss Account.
(2) Balance Sheet Ratios :
When two items or groups of items appearing in the balance sheet are compared the ratio so obtained is a balance sheet ratio. E.g. A ratio establishing relationship between current assets and current liabilities is a balance sheet ratio.
(3) Composite Ratios :
A ratio showing the relationship between one items taken from balance sheet and another taken from profit and loss account is a composite ratio or a combined ratio known as balance sheet and revenue statement ratio. A return on capital employed shows the proportion of net profit to capital employed and it is a composite ratio.
(B) Functional Classification:~
Ratios are also grouped in accordance with certain tests. On this basis there are four categories of ratios.
(1) Liquidity Ratios:
These ratios indicate the position of liquidity. They are computed to ascertain whether the company is capable of meeting its short-term obligations from its short term resources. For example, current ratio shows the capacity of a firm to meet its current liabilities as and when they mature. E.g.
(a) Current ratio
(b) Liquidity ratio
(c) Acid-test ratio
(2) Profitability Ratios:
A number of ratios are designed to indicate the profitability of the business and are grouped into the category of profitability ratios. For example, Return on capital employed is an example of profit ratio. E.g.
(a) Gross profit ratio
(b) Net profit ratio
(c) Expenses ratio
(d) Operating ratio
(e) Return on capital employed ratio
(f) Return on shareholders funds
(g) Debt service coverage ratio
(3) Leverage Ratios:
The composition of capital of business and the proportion of owners` capital and capital provided by outsiders are reflected by leverage ratios. For example, gearing ratio showing the relationship between the preference capital and ordinary capital is a leverage ratio. E.g.
(a) Proprietary ratio
(b) Debt-Equity ratio
(c) Gearing ratio
(d) Fixed capital- Fixed assets ratio
(4) Activity or Efficiency Ratios:
These are the ratios showing the effectiveness with the resources if the business are employed. It signifies the efficiency of the management. For example, stock turnover is an activity ratio, showing the number of times the average stock turnover turned over during the year. E.g.
(a) Debtors ratio or turnover
(b) Creditors ratio or turnover
(c) Total assets turnover
(d) Fixed assets turnover