Question

What financial statements and financial ratios can be used to quantify the financial health of a firm. How might this information be useful to individuals outside of the accounting world?  Please include examples to support your posting.

Answer 1

Financial statements that are used to understand the financial health of the firm are Balance sheet, Profit and loss account, Income statement and Cash flow statement. These statements give the picture about the financial position of the firm and the financial transactions that has taken place in the firm. The financial ratios that are used to quantify the financial position of a firm are broadly classified into:

Liquidity ratio: It gives an idea about the ability of the company to pay-off the debt and have liquid cash. example: Current ratio, quick ratio etc.

Profitability ratio: It helps to understand the ability of the company to generate profits over a given period of time. example: Gross profit margin, Net profit margin.

Efficiency ratio: It is the analysis of the way in which the company is able to use its assets and revenue. example: Inventory turnover, accounts receivable turnover, accounts payable turnover etc.

Solvency ratio: It is used to measure the extent in which the firm's assets will be useful to pay off the debts of the company. example: Debt to Equity ratio, financial leverage etc.