Definition of Financial Ratios
Financial Ratios are tools that are used for doing comparison between different pieces of financial information to arrive at a conclusion regarding the profitability, operational activity, debt and liquidity of the business. Financial Ratios are calculated from the Income Statement, Balance Sheet and Cash Flow Statement of an organization. The topic of financial Ratio analysis is very vast as it covers many Ratio analysis formulas and each Ratio has different application which makes students to look for Financial Ratio Analysis Assignment Help.
Types of Financial Ratio
Financial Ratios are of 5 types. They are as follows:
- Profitability Ratios: These ratio deals with the acceptable return in the business. These ratio measures how company is using its assets and controlling the expenses to generate a return which would be accepted by the investors. Some of the examples of profitability ratios are Gross Margin Ratio, Profit Margin, Return on Assets, Return Capital employed and Return on Equity.
- Liquidity Ratios: These ratio measure the company’s present availability of cash to pay the debt. Some of the examples of Liquidity ratios are Quick Ratio, Acid Test Ratio, Current Ratio, Working Capital Ratio, and Times Interest Earned Ratio.
- Activity Ratios: These ratio measures how effectively firm is using its resources.
- Solvency Ratios: These ratio measures firms ability to pay long term debt.
- Market Ratios: These ratios are concerned with the return on investment to the Shareholders and the relationship between Value of Share and return on the investment in company’s Share.
Analysis of Financial Ratios
Financial Ratios analysis is an important tool for business for checking whether they are at par with the industry standards or not. Ratios are considered to be easiest form for any business to understand. These ratios calculated are compared with the industry standard for knowing the current financial position comparing to market standard. For Example: Current Ratio of a Company is 1.5 whereas industry standard is 2. This means the company has less ability to pay short term obligations comparing to other companies working in same dimension.
Importance of Financial Ratios Analysis
- Financial Ratio analysis does a trend analysis which allows companies to make and implement financial plans and take corrective actions wherever required. This helps in making correction in short term financial plans.
- Financial Ratio analysis helps management to know how well the company is utilizing its asset and managing its liabilities. For Example: Inventory turnover ratio helps to know the business when management needs to order for inventory. This presents the business from losing their sales due to stock out.
- Financial Ratios helps business to keep track over any new opportunity available. Liquidity Ratios keeps the management informed about cash availability and brings harmony in financial plan.
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