A financial ratio is a relationship between two financial variables. It helps to ascertain the financial condition of a firm.
Ratio analysis is a process of identifying the financial strengths and weaknesses of the firm. This may be accomplished either through a trend analysis of the firm s ratio over a period of time or through a comparison of the firm’s ratios with its nearest competitors and with the industry averages
The four most important financial dimensions, which a firm would like to analyze, are:
(a)Liquidity
(b)Leverage
(c)Activity
(d)Profitability
Liquidity ratios measure the firm’s ability to meet current obligations and are calculated by establishing relationship between current assets and current liabilities.
Leverage ratios measure the proportion of outsider capital in financing the firm’s asset and are calculated by establishing relationship between borrowed capital and equity capital.
Activity ratios reflect the firm’s efficiency in utilizing its assets in generating sales and are calculated by establishing relationship between sales and assets.
Profitability ratios measure the overall performance of the firm by determining the effectiveness of the firm in generating profit, and are calculated by establishing relationship between profit figures on the one hand, and sales and assets on the other. The following is the summary of the most important financial ratios:
Summary of Ratios
Liquidity Ratios:
1) Current ratio = current assets / Current liability
2) Quick ratio = (Current assets – Inventory)/current liabilities
3) Interval measure = (Current assets-Average daily cash)/ Operating expenses
Leverage Ratio:
1) Total debt ratio = Total debt / Capital employed
2) Debt equity ratio = Net worth /Total debt
3) Capital equity ratio = (Capital Employed - Net assets)/ Net worth
4) Interest coverage = EBDIT/ Interest
Activity Ratios:
1) Inventory turnover = (Cost of goods- sales)/ Inventory
2) No. of days ,Inventory = 360 / Inventory turnover
3) Debtors Turnover= Credit sales or sales / Debtors
4) Collection Period= 360 / Debtors turnover
5) Assets turnover= (Sales - Net assets)/ Capital employed
Ratio analysis is a process of identifying the financial strengths and weaknesses of the firm. This may be accomplished either through a trend analysis of the firm s ratio over a period of time or through a comparison of the firm’s ratios with its nearest competitors and with the industry averages
The four most important financial dimensions, which a firm would like to analyze, are:
(a)Liquidity
(b)Leverage
(c)Activity
(d)Profitability
Liquidity ratios measure the firm’s ability to meet current obligations and are calculated by establishing relationship between current assets and current liabilities.
Leverage ratios measure the proportion of outsider capital in financing the firm’s asset and are calculated by establishing relationship between borrowed capital and equity capital.
Activity ratios reflect the firm’s efficiency in utilizing its assets in generating sales and are calculated by establishing relationship between sales and assets.
Profitability ratios measure the overall performance of the firm by determining the effectiveness of the firm in generating profit, and are calculated by establishing relationship between profit figures on the one hand, and sales and assets on the other. The following is the summary of the most important financial ratios:
Summary of Ratios
Liquidity Ratios:
1) Current ratio = current assets / Current liability
2) Quick ratio = (Current assets – Inventory)/current liabilities
3) Interval measure = (Current assets-Average daily cash)/ Operating expenses
Leverage Ratio:
1) Total debt ratio = Total debt / Capital employed
2) Debt equity ratio = Net worth /Total debt
3) Capital equity ratio = (Capital Employed - Net assets)/ Net worth
4) Interest coverage = EBDIT/ Interest
Activity Ratios:
1) Inventory turnover = (Cost of goods- sales)/ Inventory
2) No. of days ,Inventory = 360 / Inventory turnover
3) Debtors Turnover= Credit sales or sales / Debtors
4) Collection Period= 360 / Debtors turnover
5) Assets turnover= (Sales - Net assets)/ Capital employed