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

## 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?

**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

**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?

**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

**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

**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

**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: –

- 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

**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: –

**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

**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

**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: –

**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

**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.