Question

What are the types of ratios and which ratio do you think is most important in analyzing the financial condition and performance of a company?

Answer 1

Financial Ratios : In layman terms, Fiancial Ratios provide the relationship between the financial statements of a company. These ratios are used by the management as well as investors of the company to identify the strength, weakness, future profitability and market competition.

The major ratios which are important in analyzing the financial condition and performance of a company are as follows:

1. Liquidity : Liquidity ratio means current ration i.e. ratio of current assets to current liabilities. This ratio is favourable only when its greater than 1 because a negative would indicate that company has more liabilites than its assets. Current ratio indicates company's ability to pay its short term liabilities

2. Solvency : Solvency ratio indicates the financial stability of the company because it measures debts to assets & equity. It measures the company's ability to meet its longer-term obligations. The common solvency ratios are:

a) debt-to-asset ratio which means ratio of total debt to total assets.

b) debt-to-equity ratio which means ratio of total debt to shareholders' equity.

3. Profitability Ratio : Profitability Ratio indicates the company's ability to earn return on its sales. The most common ratios are :

a) Gross Profit Margin : Ratio of gross profit (sales minus cost of goods sold) to sales.

b) Operating Profit Margin : Ratio of operating income (gross income less operating expenses) to sales.

c) Net Profit Margin : Ratio of net income (operating profit minus interest and taxes) to sales.

d) Return on Assets : Ratio of net income to total assets.