Question

List at least 5 solvency ratios, 5 liquidity ratios, and 5 profitability ratios, showing the formula for each and a brief explanation of why they are useful.  

Answer 1

Answer :

Solvency ratios :

1. Debt to equity ratio  = Total debt / Total equity

It shows the percentage of company's financing that comes from creditors or investors.

2. Fixed Charge Coverage Ratio = (EBIT + Fixed charges) / (Interest + Fixed charges)

It shows a firm's ability to pay all its fixed charges.

3. Interest coverage ratio = Earning before interest and tax / Interest expense

It shows company's ability to make interest payment on its debt.

4. Debt ratio = Total liability / Total Assets

Debt ratio helps in showing company's ability to pay off its debts be selling its assets.

5. Proprietary ratio = Shareholders fund / Net assets

It shows relationship between the funds of all shareholders and net assets.

Liquidity ratios :

1. Current ratio = Current assets / Current liabilities

It measures a firm's ability to pay off its current liabilities.

2. Quick ratio = (Current assets - Inventory - Prepaid expenses) / Current liabilities

It measures a firm's ability to pay off its short term obligations with its most liquid assets available.

3. Days sales outstanding ratios = (Accounts receivable / Total credit sales) x No. of days in sales

It shows average number of days in which company collects its payment from customer after sales is made.

4. Cash ratio = Cash and cash equivalents / Current liabilities

It is refinement of quick ratio. It measures a firm's ability to pay off its short term obligations with cash and cash equivalents.

5. Absolute liquidity ratio = (Cash and cash equivalent + marketable securities) / Current liabilities

It measures a firm's ability to pay off its current liabilities with its cash and cash equivalents and marketable securities both.

Profitability ratios :

1. Gross Profit ratio = Gross Profit / Net sales x 100

It shows  gross profit percentage of company.

2. Net Profit ratio = Net Profit / Net sales x 100

It shows overall profitability i.e net profit percentage of company.

3. Return on Assets = Net Profit / Total assets x 100

It shows earning per rupee of assets invested in company.

4. Price earnings ratio = Market price per share / Earning per share

This ratio is used by investors to check whether the price of share of company is overvalued or undervalued.

5. Earnings per share = (Net Profit - Preferred Dividend) / Total no. of common stock outstanding

It measures the earning available to common stockholders on each stock hold.