Financial Ratios

Ratio Analysis is a technique of comparing different financial ratios produced from a company's financial statements, ratio analysis is a technique used in financial analysis to assess a company's financial performance and health. These ratios offer important information about the profitability, liquidity, solvency, efficiency, and overall operational performance of a company. Ratio analysis is a tool used by financial analysts, creditors, investors, and management to examine a company's financial health and make educated decisions.



Liquidity Ratio

The ability of a business to satisfy its short-term financial obligations without seriously disrupting its operations is measured by liquidity ratios, which are financial indicators. 
These measures evaluate a company's liquidity, or its capacity to quickly turn assets into cash. The fast ratio (sometimes called the acid-test ratio) and the current ratio are the two most popular types of liquidity ratios. 

Types of Liquidity Ratio

1. Current Ratio:

Formula: Current Ratio = Current Assets / Current Liabilities

2. Quick Ratio (Acid-Test Ratio):

Formula: Quick Ratio = (Cash + Marketable Securities + Accounts Receivable) / Current Liabilities

3. Cash Ratio (Absolute Quick Ratio):

Formula: Cash Ratio = Cash Assets / Current Liabilities


Solvency Ratio 

Solvency ratios are a class of financial indicators that evaluate a company's capacity to meet its long-term financial obligations and its general financial stability. They are also referred to as leverage ratios or financial leverage ratios. These statistics shed light on a company's capital structure, the volume of debt financing it uses, and its ability to pay back debts. Solvency ratios are crucial for assessing the risk associated with a company's financial structure and are important for investors as well as creditors.

Types of Solvency Ratio 

1. Debt-to-Equity Ratio (D/E Ratio):

Formula: Debt-to-Equity Ratio = Total Debt / Shareholders' Equity

2. Interest Coverage Ratio (ICR):

Formula: Interest Coverage Ratio = Earnings Before Interest and Taxes (EBIT) / Interest Expense 

3.  Debt Ratio:

Formula: Debt Ratio = Total Debt / Total Assets

4. Debt to Capital Ratio:

Formula: Debt to Capital Ratio = Total Debt / (Total Debt + Shareholders' Equity) 


Profitability Ratios

Profitability ratios are financial indicators that evaluate a company's capacity to produce profit in relation to its revenue, assets, equity, and other financial measures. These ratios offer insightful information regarding a company's financial performance and profitability, which is essential for assessing its general health and investor appeal.

Types of Profitability Ratios

1. Gross Profit Margin:

Formula: Gross Profit Margin = (Gross Profit / Revenue) × 100%

2. Net Profit Margin:

Formula: Net Profit Margin = (Net Profit / Revenue) × 100%

3. Operating Profit Margin:

Formula: Operating Profit Margin = (Operating Profit / Revenue) × 100%

4. Return on Assets (ROA):

Formula: ROA = (Net Profit / Total Assets) × 100%

5. Return on Equity (ROE):

Formula: ROE = (Net Profit / Shareholders' Equity) × 100%

6. Earnings Before Interest and Taxes (EBIT) Margin:

Formula: EBIT Margin = (EBIT / Revenue) × 100%

7. Return on Investment (ROI):

Formula: ROI = (Net Profit / Investment Cost) × 100%

8. Profit Margin on Sales:

Formula: Profit Margin on Sales = (Net Profit / Sales) × 100%

9. Gross Operating Profit Ratio:

Formula: Gross Operating Profit Ratio = (Gross Profit - Operating Expenses) / Revenue 


Efficiency Ratios

Efficiency ratios, often referred to as activity ratios, are financial measurements that assess how well a business uses its assets and liabilities to produce revenue and run its operations. These statistics shed light on a company's operational effectiveness, inventory control, accounts receivable collection, and asset usage. 

Types of Efficiency Ratios

1. Inventory Turnover Ratio:

Formula: Inventory Turnover Ratio = Cost of Goods Sold (COGS) / Average Inventory

2. Accounts Receivable Turnover Ratio:

Formula: Accounts Receivable Turnover Ratio = Net Credit Sales / Average Accounts Receivable

Accounts Payable Turnover Ratio:

Formula: Accounts Payable Turnover Ratio = Purchases (or COGS) / Average Accounts Payable

4. Asset Turnover Ratio:

Formula: Asset Turnover Ratio = Revenue / Average Total Assets


Market Ratios

Market Ratios, otherwise called valuation ratios, are monetary measurements used to evaluate an organization's engaging quality to financial backers and its overall valuation in the securities exchange. These ratios assist financial backers and experts with checking whether an organization's stock is exaggerated or underestimated contrasted with its monetary presentation and potential for development. 

Types of Market Ratios

1. Price-to-Earnings Ratio (P/E Ratio):

Formula: P/E Ratio = Market Price per Share / Earnings per Share (EPS)

2. Price-to-Sales Ratio (P/S Ratio):

Formula: P/S Ratio = Market Price per Share / Sales per Share

3. Price-to-Book Ratio (P/B Ratio):

Formula: P/B Ratio = Market Price per Share / Book Value per Share

4. Enterprise Value (EV) to EBITDA Ratio:

Formula: EV/EBITDA Ratio = Enterprise Value / Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA)

5. Market Capitalization:

Market capitalization is the total market value of a company's outstanding shares. It is calculated by multiplying the current market price per share by the total number of outstanding shares.

6. Price/Earnings-to-Growth (PEG) Ratio:

Formula: PEG Ratio = P/E Ratio / Annual Earnings Growth Rate


The comparison of these financial ratios with time trend indicators and against competitors or industry benchmarks, is part of the ratio analysis process. It helps stakeholders to have a full understanding of how the company is performing, strengths and weaknesses, as well as possible areas for improvement. This is a key instrument for the organization's investment decisions, assessment of creditworthiness and guidance in organizational planning and finance management. 

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