Question

What are the different types of ratios in Financial Statement analysis? Why are they so use useful?

Answer 1

Different types of ratio used in financial statement analysis are:

1. Activity ratio: This ratio tells us that how well a firm utilizes its various assets such as inventory and fixed asset. Activity ratio involves various types of ratios like inventory turnover, receivables turnover and total asset turnover. Activity ratio are also known as asset utilization or turnover ratio.

2. Liquidity ratio: This ratio is used to check the the ability of a firm to pay its short-term obligation. It includes current ratio, quick ratio, cash ratio, defensive interval and cash conversion cycle

3. Solvency ratio: This ratio is used to analyse firm's financial leverage and ability to meet its long-term obligation. It includes different ratio like debt to equity ratio, debt to capital, debt to asset, financial leverage, interest coverage and fixed charge coverage.

4. Profitability ratio: This ratio tells that how well a company generates operating profits and net profits from its sales. It includes net profit margin, gross profit margin, operating profit margin etc.

5. Valuation ratio: this ratio is used to compare the relative valuation of companies. It includes ratio like sales per share, earning per share and price to cash flow per share.

These ratios are useful:

• It helps in project future earnings and cash flow
• This ratio helps to make economic decision of the firm like it helps investor in deciding whether investor should invest in firm or not
• These ratios help in evaluating company's past performance and current financial position in order to see the company's ability to earn profit and generate cash flows in the future.