The word “ratio” is a mathematical term which takes two numbers and compares them to find out how they relate to each other. Ratio analysis, then, is the process of figuring out how one number relates to another by comparing them. In finance, the most common ratios are used to measure the health of a company’s balance sheet.
What is Ratio Analysis?
Ratio analysis is a financial statement analysis technique that is used to obtain a quick indication of a company’s financial health. It is also used to compare a company’s financials to its industry average or other companies in its sector. There are many different types of ratios that can be analyzed, but some of the most common include:
– Liquidity Ratios: These ratios measure a company’s ability to pay its short-term obligations.
– Activity Ratios: These ratios measure a company’s efficiency in using its assets and liabilities.
– Leverage Ratios: These ratios measure a company’s debt burden.
– Coverage Ratios: These ratios measure a company’s ability to meet its interest payments.
Types of Ratio Analysis
There are different types of ratio analysis, each with its own advantages and disadvantages. T
he most common type of ratio analysis is financial ratio analysis, which looks at the financial statements of a company to identify strengths and weaknesses. Other types of ratio analysis include operational ratio analysis and market share ratio analysis.
The Purpose of Ratio Analysis
Ratio analysis is a financial analysis tool that is used to evaluate various aspects of a company’s business and operating performance. Ratios can be used to compare a company’s financial results to those of its competitors, or to industry averages.
There are many different types of ratios that can be calculated, each providing insights into different aspects of a company’s business. Some of the most common ratios include:
-Profitability ratios: These ratios measure a company’s ability to generate profits.
-Liquidity ratios: These ratios measure a company’s ability to meet its short-term obligations.
-Solvency ratios: These ratios measure a company’s ability to meet its long-term obligations.
-Efficiency ratios: These ratios measure a company’s use of its resources.
How to Conduct a Ratio Analysis
Ratio analysis is a financial statement analysis tool that helps investors and creditors compare different aspects of a company’s financial health.
There are four key types of ratios that analysts use when conducting a ratio analysis:
-Liquidity ratios show how well a company can pay its short-term debts.
-Profitability ratios show how well a company is generating profits.
-Activity ratios show how efficiently a company is using its assets to generate sales.
-Solvency ratios show how well a company can pay its long-term debts.
Here’s a quick overview of each type of ratio:
Liquidity Ratios
-Current ratio: The current ratio measures a company’s ability to pay its short-term debts with its current assets.
-Quick ratio: The quick ratio measures a company’s ability to pay its short-term debts with its quick assets, which are assets that can be quickly converted into cash.
Profitability Ratios
-Gross profit margin: The gross profit margin measures the percentage of revenue that a company keeps after subtracting the cost of goods sold.
-Operating profit margin: The operating profit margin measures the percentage of revenue that a company keeps after subtracting expenses, other than cost of goods sold. -Return on assets: The return on assets shows how profitable a company is relative to its total assets. -Return on equity: The return on equity measures the profitability of a company’s common stock relative to its total equity. Liquidity Solvency Profitability Ratio Ratio Ratio Current ratio Quick ratio Gross profit margin Operating profit margin Return on assets Return on equity Source: KPMG
In order for these ratios to work well, you have to know what goes into them; but it isn’t always easy for laymen to understand what makes up an asset or an expense.
Conclusion
Ratio analysis is an incredibly useful tool for business owners and managers to assess various aspects of their company’s financial health. While there are many different types of ratios that can be analyzed, it is important to choose the right ones for your particular business in order to get the most accurate picture possible.
With careful planning and execution, ratio analysis can give you invaluable insights into your company’s overall financial health and performance.
