Question

in 200 words or more What are the 5 categories of financial ratios and their purpose? Fully explain. give example of each

Answer 1

Five Categories of Financial Ratios:

.1Liquidity Ratios.

..2Activity Ratios.

.3 Debt Ratios.

.4Profitability Ratios.

.5 Market Ratios.

.1 Liquidity ratios indicate ability of the company to meet its financial obligations.

Examples:

Current Ratio=(Current assets)/(Current Liabilities)

Quick ratio=(Quick Assets)/(Current Liabilities)

Quick assets=Cash+ Marketable securities+ Accounts receivable

.2 Activity Ratios indicates efficiency of operations , the ability of the firm to convert different accounts in balance sheets like inventory, accounts receivable, fixed assets etc into cash or sales.

Examples:

Accounts Receivable Turnover=( sales)/(Average accounts receivable

Number of days sales in receivable=365/Receivable turnover

Inventory turnover=Cost of goods sold/Average inventory

Number of days sales in inventory=365/inventory turnover

Asset turnover=Sales/total assets

.3.Debt ratio indicates the financial leverage of the firm,the proportion of debt used to fund the assets.

Examples:

Debt Ratio=Total Debt/Total asset

Times interest earned(TIE)=Earning before interest and taxes/Interest expenses

This is also a solvency ratio and indicates whether the firm is able to pay interest expenses

TIE is also known as coverage ratio

Debt to Equity Ratio=Total Debt/Shareholders Equity

.4.Profitability ratios indicate the profitability of the company.

Examples:

ROCE (Return on capital Employed)=EBIT/Capital Employed

EBIT=Earning Before Interest and Taxes.

It measures Profitability and efficiency of use of capital.

Capital employed: Total assets – current liabilities

Return on total asset= Net income/Total assets

Gross Profit Margin=Gross Profit/ Sales

Net Profit Margin=Net Income/Sales

.5.Market ratios are used to evaluate current market price of the stock:

These ratios are closely watched by the investors

Examples:

Earnings per share on common stock=Total Earnings/Number of shares outstanding

Price earning ratio=Market price/Earning per share

Dividend Yield= Dividend per share/ Market price

Book Value per share=Shareholders equity/ Number of shares outstanding

Price to book value=Market Price/Book value per share