Question

Explain the purpose of every Ratio 1 by 1.

leverage ratios

liquidity ratios

profitability ratios

operations ratios

Answer 1

leverage ratios

A leverage ratio is a financial ratio that determines the level of debt incurred by a business. These ratios provide an indication of the company’s debt obligation to the assets or equities.
A high ratio indicates that a business may have incurred a higher level of debt than expected, which needs to be addressed with ongoing cash flows. Broadly there are two leverage ratios that are frequently used:

Debt ratio. Compares assets to debt

Debt to equity ratio. Compares equity to debt.

liquidity ratios

A liquidity ratio is a financial ratio that determines a company’s ability to pay its short-term debt obligations i.e. to meet its short-term liabilities with its short-term assets. If we categorise the importanc eof liquidity ratio it can be helps to determine the following factors:

1. Determine the ability to cover short-term obligations

2. Determine creditworthiness for the creditors

3. Determine investment worthiness for the investors.

Also, broadly following are the types of liquidity ratios commonly used:

1. Current Ratio = Current Assets / Current Liabilities
2. Quick Ratio = (Cash + Accounts Receivables + Marketable Securities) / Current Liabilities
3. Cash Ratio = (Cash + Marketable Securities) / Current Liabilities

profitability ratios

Profitability ratios are the financial ratios which measures and evaluates the ability of a company to generate profit relative to revenue. It shows how well a company utilizes its assets to produce profit and value to shareholders. These ratios are used as a way to measure a company's performance or simply, the capacity of a company to make a profit. higher is this ratio, better it is for the investors and creditors.Broadly the ratios can be categorised as:

1. Margin Ratios - Company’s ability to convert sales into profits.

Examples are operating profit margin, gross profit margin, cash flow margin, EBIT, , net profit margin, EBITDAR, NOPAT, EBITDA, operating expense ratio.

2.  Return Ratios - Represents the company’s ability to generate returns to its shareholders.

Examples are ROA, ROE, return on debt, return on invested capital, and return on capital employed.

Operating ratios

The operating ratio is a financial ratio that provides an overview of the efficiency of a company's management to determine day-to-day operational performance. This ratio basically compares operating expenses to net sales. It shows if the cost component in the sales value is within the normal range. A low operating ratio means a high net profit ratio. If the ratio is increasing, implies that the organization is not working efficiently -  which means operating costs are going up relative to revenue or sales.

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