Types of Ratio Analysis

Ratio analysis is the method of evaluating financial ratios which are required to reflect a firm’s current financial output utilizing a few different forms of ratios like liquidity, profitability, activity, and debt ratios.

Or, In order to measure a firm’s financial fitness. The values often used to measure a firm’s financial ratios are derived from the firm’s financial statements.

There are 6 types of Ratio Analysis

  • Liquidity Ratios
  • Profitability Ratios
  • Solvency Ratios
  • Turnover Ratios
  • Earnings Ratio
Types of Ratio Analysis

Liquidity Ratios

This type of ratio aids in determining a business’s capacity to meet its short debt obligations. A stronger liquidity ratio indicates that the business is good at making cash.

Liquidity ratios can be classified into the following categories: –

Must Read – What is Liquidity Ratio?

  1. Current Ratio: 

The current ratio is the ratio of a firm’s current assets to current liabilities. The current ratio is designed to determine a firm’s ability to fulfil its debt obligations for the next 12 months. A stronger current ratio indicates that the firm is well-positioned to meet its short-term debt obligations.

The quick ratio is used to determine a firm’s capacity to pay off its current liabilities in the shortest amount of time.

This form of ratio assists in assessing a firm’s capabilities to attain adequate income.

Current Ratio = Current Assets / Current Liabilities

  1. Quick Ratio: 

The quick ratio is used to determine a firm’s capacity to pay off its current liabilities in the shortest amount of time.

This form of ratio assists in assessing a firm’s capabilities to attain adequate income.

Quick Ratio = (Cash and Cash Equivalents + Marketable Securities + Accounts Receivables) / Current Liabilities

Profitability Ratios

This form of ratio assists in assessing a firm’s capabilities to attain adequate income.

The given below are some examples of profitability ratios: –

Must Read – What is Profitability Ratio?

  1. Gross Profit Ratios:

GP ratios are determined to reflect a firm’s operating profits by rendering certain adjustments to COGS, or cost of goods sold.

Gross Profit Ratio = (Gross Profit / Net Sales) x 100

  1. Net Profit Ratio: 

Net profit ratios are used to measure a firm’s total productivity by deducting all cash and non-cash expenses.

Net Profit Ratio = (Net Profit / Net Sales) x 100

  1. Operating Profit Ratio: 

The operating profit ratio is intended to measure a firm’s financial strength and willingness to pay both short & long-term debt obligations.

Operating Profit Ratio = (Earnings Before Interest and Taxes / Net Sales) * 100

  1. Return on Capital Employed (ROCE): 

Return on capital employed is intended to measure a firm’s profitability in relation to the money spent in the business.

Return on Capital Employed = Earnings Before Interest and Taxes / Capital Employed

Solvency Ratios

Solvency ratios are a form of ratio which is needed to calculate if a business is solvent and worthy of repaying its debt obligations.

Must Read – What is Solvency Ratio?

The given below are examples of solvency ratios: –

  1. Debt-to-Equity Ratio:

The debt-equity ratio is described as the ratio of total debt to shareholders’ funds. The D/E ratio is used to assess a firm’s leverage. A company’s optimal debt-equity ratio is 2:1.

Debt Equity Ratio = Total Debts / Shareholders Fund

  1. Interest Coverage Ratio: 

The interest coverage ratio is intended to calculate a company’s solvency in the coming years, and also how many times the income received by that organisation is capable of matching its interest-related expenditures.

Interest Coverage Ratio = Earnings Before Interest and Taxes / Interest Expense

Turnover Ratios

Turnover ratios are used to calculate how successfully a firm’s financial assets & liabilities were utilized to raise profits

Must Read – What is Turnover Ratio?

The given below are examples of turnover ratios: –

  1. Fixed Asset Turnover Ratios: 

The fixed assets turnover ratio is utilized to measure a firm’s performance in extracting income from its fixed assets.

Fixed Assets Turnover Ratio = Net Sales / Average Fixed Assets

  1. Inventory Turnover Ratio: 

The inventory turnover ratio is used to measure how rapidly a business turns its stocks into sales.

Inventory Turnover Ratio = Cost of Goods Sold / Average Inventories

  1. Receivable Turnover Ratio: 

The receivable turnover ratio is used to measure a firm’s ability in accumulating or realizing its account receivables.

Receivables Turnover Ratio = Net Credit Sales / Average Receivables

Earnings Ratio

The earnings ratio is used to calculate the profits that a company makes for its investors.

The given below are examples of earnings ratios: –

  1. Profit Earnings Ratio: 

The profit-earning capability of the organisation is shown by the P/E ratio.

Profit Earnings Ratio = Market Price per Share / Earnings per Share

  1. Earnings per Share (EPS): 

EPS denotes an equity holder’s profits based on a single stock.

EPS = (Net Income – Preferred Dividends) / (Weighted Average of Outstanding Shares)

Ratio analysis serves as the foundation for financial analysis. Ratio analysis is often seen by financial statement readers to get a deeper view of a firm’s health.