Financial Ratio or Accounting Ratio is used to evaluate the overall financial condition of a corporation or an organization. In firms, managers, potential stakeholders/ owners, current stakeholders, and the firm’s creditors use financial ratios. Economic analysts compare these financial ratios to determine the strength and weaknesses of an organization.
What is the Liquidity Ratio & How it is determined?
The liquidity ratio is used to determine a company’s ability to pay its short-term debts obligations; It helps determine how the company should use its current or liquid assets to cover its current liabilities!
The three main liquidity ratios are the current ratio, quick ratio, and cash ratio.
Type of Liquidity Ratios:
1- Current Ratio = Current Assets/ Current Liabilities
The current ratio is the simplest liquidity ratio to calculate and interpret. Anyone can easily find the current asset and current liabilities line items on a company’s balance sheet. Divide current assets by current liabilities, and you will arrive at the current ratio.
2- Quick Ratio = Liquid Assets/Current Liabilities
Liquid assets such as cash, accounts receivables, and marketable securities. It leaves out current assets such as inventory and prepaid expenses because the two are less liquid.
So, the quick ratio is more of a true test of a company’s ability to cover its short term obligations.
3- Absolute Liquid Ratio (Cash Ratio) = Absolute Liquid Assets/Current Liabilities
Cash ratio or absolute liquid ratio are cash and marketable securities. They are the assets that are most readily available to a company to pay short-term obligations.
What is the Profitability Ratio & How it is determined?
Profitability ratios evaluate a company’s ability to earn profits from its sales or operations, balance sheet assets, or shareholders’ equity.
Type of Profitability Ratios:
1- Gross Profit ratio: Gross Profit/Net Sales X 100
Gross Profit ratio is the Gross profit divided by net sales whereas gross profit is the profit made by a business or organization by subtracting all the costs which relate to its manufacturing and selling its products or services.
2- Operating Cost Ratio: Operating Cost/Net Sales X 100
Operating Cost Ratio is Operating cost divided by net sales whereas operating cost is the sum of all operating expenses and all the cost which relate to its manufacturing and selling its products or services (COGS)
3- Operating Profit Ratio (Net Profit Ratio): Operating Profit/Net Sales X 100
Operating Profit Margin is a profitability or performance ratio that reflects the percentage of profit a company produces from its operations, prior to subtracting taxes and interest charges
4- Return on Investment (ROI) ratio: Net Profit After Interest And Taxes/ Shareholders Funds or Investments X 100
The return on investment ratio (ROI), also known as the return on assets ratio, is a profitability measure that evaluates the performance or potential return from a business or investment.
5- Return on Capital Employed Ratio: Net Profit after Taxes/ Gross Capital Employed X 100
6- Earnings Per Share Ratio: Net Profit After Tax & Preference Dividend /No of Equity Shares
7- Dividend Pay Out Ratio: Dividend Per Equity Share/Earning Per Equity Share X 100
8- Earning Per Equity Share: Net Profit after Tax & Preference Dividend / No. of Equity Share
9- Dividend Yield Ratio: Dividend Per Share/ Market Value Per Share X 100
10- Price Earnings Ratio: Market Price Per Share Equity Share/ Earning Per Share X 100
11- Net Profit after Taxes / Shareholders Net Worth X 100
Working Capital Ratios
Net Sales / Inventory
Debtors Turnover Ratio
Total Sales / Account Receivables
Debt Collection Ratio
Receivables x Months or days in a year / Net Credit Sales for the year
Creditors Turnover Ratio
Net Credit Purchases / Average Accounts Payable
Average Payment Period
Average Trade Creditors / Net Credit Purchases X 100
Working Capital Turnover Ratio
Net Sales / Working Capital
Fixed Assets Turnover Ratio
Cost of goods Sold / Total Fixed Assets
Capital Turnover Ratio
Cost of Sales / Capital Employed
Capital Structure Ratios
Debt Equity Ratio
Total Long Term Debts / Shareholders Fund
Shareholders Fund/ Total Assets
Capital Gearing ratio
Equity Share Capital / Fixed Interest Bearing Funds
Debt Service Ratio
Net profit Before Interest & Taxes / Fixed Interest Charges
Overall Profitability Ratio
Overall Profit Ability Ratio
Net Profit / Total Assets