Question

What 4 major groupings can Financial ratios be divided?

Answer 1

The major groupings for financial ratios are:

1) Liquidity ratios:

These consist of the current ratio, acid test ratio, net working capital etc., and seek to evaluate the short term financial or liquidity position of the firm.

The objective is to test whether the firm will be able to meet its short term obligations as when they become due.

2) Solvency ratios;

These include the Total debt ratio, Debt equity ratio, Times interest earned ratio, etc and seek to evaluate the long term financial position of the firm.

The attempt is to find out whether the firm's total indebtedness ensures long term financial stability and the riskiness of its capital structure.

3) Asset management ratios:

Some of the ratios used are the receivables turnover ratio, inventory turnover ratio, current assets turnover ratio, fixed assets turnover ratio, total assets turnover ratio etc., which highlight the efficiency with which the assets of the firm are utilized in the operations.

4) Profitability ratios:

These can be the gross profit ratio, operating profit ratio & net profit ratio which are based on sales or the return ratios like the return on total assets, return on equity etc. These ratios reflect the overall efficiency of the firm in generating profits or returns.