Question

Describe the three categories of ratios used in ratio analysis. When working on assessing the company you chose, which of these ratios do you think is the most important indicator of successful performance, why

Answer 1

Ratios important to analyse a company:
Liquidity ratio consists of current, quick ratio and cash ratio. Current ratio   is the ratio of the current assets to current liabilities. If current ratio is greater than 1 then the company can pay off its short liabilities through its short term assets.
Quick ratio is the current assets minus inventories to the current liabilities. It focuses on liquidity other than the inventory.
Cash Ratio is the ratio of cash and cash equivalent the current liabilities. The higher the cash ratio with respect to the market the higher is its liquidity position.

Debt management ratios are Debt to total Asset ratio, debt equity ratio, time interest earned ratio and EBIDTA coverage Ratio.
Debt to Total Assets ratio included the short term and long term debt as proportion to asset. Higher the ratio as compared to industry average more is the risk involved in the firm. Higher Debt equity ratio also indicates higher risk. Time interest earned ratio is EBIT to Interest paid. It indicated the debt repaying capacity of the firm and important for creditors. EBIDTA coverage Ratio = EBIDTA/ (Interest + Principal) . This also indicates the repaying capacity of the firm in terms of interest and principal.

DuPoint ratio for calculation of ROE includes net profit margin , Average assets turnover and Equity multiplier. ROE = Net profit Margin* Asset Turnover * Equity Multiplier. ROE is broken down into profitability, operating efficiency and the capital structure of the firm. It helps in identifying which portion contributes least or most t0 the ROE.

Profitability ratio (Net profit margin, Gross Profit Margin, ROE)
This ratio is highly important for shareholders who want good return on investments and this helps in identifying good profitable stocks. This ratio is highly important for the continued operation of a firm. A firm with low profitability ratios may cease to exist in future.

The most important ratio is profitability ratio as investors are interested in the Return on equity. Based on this ratio they gauge their returns