Basic Types of Financial Ratios
Financial Ratios That Measure the Company’s Performance
Financial ratios represent the association between the statements of financial items. We can identify the weakness and strengths of the company using these ratios. Financial ratios can also estimates the financial performance of the upcoming days. Many of the investors use these ratios to compare their company with other companies in the industry. Ratios are always useful when they used to compare with the industry average or the historical data; standalone they are of no use. There are four basic kinds of financial ratios below; we group them in two categories due to the similar factors between them.
Liquidity and Solvency
The liquidity has the common ratio called ‘current ratio’. Hence, the current ratio is the ratio of all the current assets of the company to the total current liabilities. To assess the ability of the company to pay the company’s short term bills, you can use the current ratio. If the ratio is greater than one then that would mean the minimum ratio, since whatever is less than one could mean that the firm is having more liabilities than the number of assets. A high ratio is much safer, because it means that the business has maximum flexibility since some of the receivable balances and items may not be alterable to cash.
On the other hand, we can use the solvency ratio to calculate the financial stability. It deals with the debts of the company relative to all its equities and assets. It is obvious that a company having too many debts would not be flexible for managing its cash flow. The most common ratio that falls in this category is debt to equity and debt to assets.
Profitability and efficiency
We can calculate the ability of the company to convert the sales money into cash flow and profit by the profitability ratios. The profitability ratios are net income margin, operating margin, gross margin. Also, we can calculate the net income ratio by dividing the net income to sales. Additionally, we can assess the net profit by subtracting the interest and taxes from operating profit. The operating margin can be calculated by taking ratio of operating profit of the company to sales. It is the profit that comes by deducting the operating expenses from the gross profit. The gross margin can be calculated by dividing the gross profit to the total sales of the company. The gross profit the sales that would be deducted from the costs of good.
Efficiency ratios consist of two most common ratios, the receivable turnover and the inventory turnover. Additionally, we can calculate the inventory ratio by dividing the cost of assets to the inventory. Also, we can calculate the receivable turnover ratio by taking ratio of total credit sales to the number of accounts that are receivables. A company would be successful by high accounts receivables.
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