Financial ratio

From the accounting data can be grouped into various classes according to financial activity or function to be evaluated short term creditors main interest is in the liquidity position or the other hand are more interested in the long term solvency and profitability of the firm’s profitability and financial condition. Management is interested in evaluating every aspect of the firm’s performance. They have to protect the interests of all parties and see that the firms grows profitably. In view of the various users of ratios.
Four important categories of ratio.
-Liquidity ratio
-leverage ratio
-Activity ratio
-Profitability ratio
1)Liquidity ratio-Liquidity ratio measure the ability of the firm meet its current obligation(liabilities).The most common ratio,Which indicate the extent of liquidity or lack of it.
a)current ratio
b)quick ratio
Current ratio-current ratio is calculated by dividing current assets by current liabilities .

current ratio=\frac{current assets}{current liability}

Current assets=Cash on those assets that can be converted into cash within a year for eg.. marketable securities,debtor and inventories ,prepaid expenses are also included in current assets.
Current liabilities-Creditors,bills payable,accured expenses short term bank loan,income tax,long term debt maturing in the current years.
2)Quick ratio=Quick ratio also called acid test ratio a relationship between quick or liquid assets and current liabilities.An assets is liquid if it can be converted into cash immediately or reasonably without a loss of value cash is the most liquid assets other assets that are considered to be relatively liquid debtor and bill receivables and marketable securities are quick assets.

Quick ratio= \frac{current assets-inventories}{current liabilities}

3)Cash ratio=Trade investment or marketable securities are equivalent of cash.

Cash ratio= \frac{cash+marketable scurities}{current liabilities}

4)Interval measure-Interval measure relates liquid assets to average daily operating  cash outflows.The daily operating expenses will be equal to cost of goods sold plus.selling administrative and general expenses less depreciation.

Interval measure= \frac{current assets-inventory}{average operating exp}

5)Net working capital ratio- The difference between current assets and current liabilities excluding short-term bank borrowing is called net working capital.

NWC= \frac{NWC}{net assets}

6)Debt ratio=Several debt ratios may be used to analyse the long term solvency of a firm.The firm may be interested in knowing proportion of the interest-bearing debt (also called funded debt) in the capital structure.It may therefore compute debt ratio by dividing total debt(TD) by capital employed(CE) or net assets.

Debt ratio=     \frac{total debt}{total debt+nt worth}

7)Debt-equity ratio=This relationship debt equity(DE) ratio is directly computed by dividing the debt  by net worth.

Debt equity ratio= \frac{total debt}{net worth}

Coverage ratio=The interest coverage ratio or the times interest earned is used to test the firm’s debt servicing capacity.The interest coverage ratio is computed by dividing earning before interest and taxes(EBIT) by interest charges.

Coverage ratio= \frac{EBIT}{Interest}

9)Inventory turnover=Inventory turnover indicate the efficiency of the firm in producing and selling its product.It is calculated by dividing the dividing the cost of good sold by the average inventory.

Invntory turnover ratio=\frac{cost of good sold}{average inventory}

10)Debtor turnover ratio=Debtor turnover is found out by dividing credit sales by average debtors.

Debtor ratio=\frac{credit sales}{average debetor}

11)Assets turnover ratio=The relationship between sales and asset is called assets turnover some assets turnover ratio can be calculated.
a)Net asset turnover-The firm can compute net assets turnover simply by dividing sales by net assets.

Net assets turnover ratio=\frac{sales}{net assets}

b)Total assets turnover=This ratio shows the firm,s ability in gnerating sales from all financial resources committed to total assets.

total assets turnover ratio=\frac{sales}{total assets}

C)Fixed current asset turnover ratio=The firm may wish to know its efficency of utilising fixed assets and current assets.

Fixed assets turnover ratio=\frac{sales}{net fixed assets}

Gross profit margin ratio=The first profitability ratio in relation to sales is the gross profit margin.It is calculated by dividing the gross profit by sales.

Gross profit margin= \frac{sales-cost of good sold}{sales}

13)Net profit margin=Net profit is obtained when operating expenses,interest and taxes are subtracted from the gross profit .The net profit margin ratio is measured by dividing profit after tax by sales.

Net profit margin= \frac{PAT}{sales}

14)Operating Expenses ratio=The operating expense ratio explains the change in the profit margin(EBIT to sales )ratio. This ratio is computed by dividing operating expenses cost of good sold plus selling expenses and general and administrative expenses (excluding interest by sales

Operating expenses ratio= \frac{operating expenses}{sales}


Leave a Reply