Types of Ratio Analysis
The different types of ratio analysis have been stated below.
Liquidity Ratios
These ratios measure a company’s ability to meet its short-term obligations. They are crucial for assessing the company's short-term financial health and operational efficiency.
- Current Ratio= (Current assets/Current liabilities)
This ratio indicates the number of times current assets can cover current liabilities. A ratio above 1 suggests good short-term financial health.
- Quick Ratio (Acid-Test Ratio)= ((current assets-inventory)/current liabilities)
This ratio refines the current ratio by excluding inventory, providing a stricter measure of liquidity.
Profitability Ratios
Profitability ratios assess a company’s ability to generate earnings relative to its revenue, assets, equity, and other financial metrics.
- Gross Profit Margin= ((Revenue-Cost of Goods Sold)/Revenue)*100
- Net Profit Margin= Net Profit/Revenue
This ratio shows the percentage of revenue that becomes net profit, reflecting overall profitability.
- Return on Assets (ROA)= Net Income/Average Total Assets
This ratio measures how efficiently a company uses its assets to generate profit.
- Return on Equity (ROE)= Net Income/ Average Total Equity
This ratio evaluates the profitability generated from shareholders’ equity.
Leverage (Solvency) Ratios
Leverage ratios assess the degree of a company's financial leverage and its ability to meet long-term obligations.
- Debt-to-Equity Ratio= Total Debt/Total Shareholders Fund
This ratio indicates the proportion of debt financing relative to equity financing. A higher ratio suggests greater reliance on debt.
- Interest Coverage Ratio= EBIT/Interest Earned
This ratio measures the company’s ability to cover interest expenses with its earnings before interest and taxes (EBIT).
Efficiency (Activity) Ratios
Efficiency ratios measure how well a company utilizes its assets and manages its operations.
- Inventory Turnover Ratio= Cost of Goods Sold/Average inventory
This ratio indicates how often inventory is sold and replaced over a period. A higher ratio suggests efficient inventory management.
- Receivables Turnover Ratio= Net Credit Sales/Average Accounts Receivable
This ratio measures how effectively the company collects its receivables. A higher ratio indicates quicker collection from customers.
- Asset Turnover Ratio= Net Sales/Average Total Assets
This ratio shows how efficiently a company uses its assets to generate revenue.
Market Valuation Ratios
Market valuation ratios provide insights into how the market views a company’s performance and prospects.
- Price-to-Earnings (P/E) Ratio= Price per Share/Earnings per Share
This ratio indicates how much investors are willing to pay for each dollar of earnings. A higher ratio suggests higher market expectations for future growth.
- Dividend Yield= Annual Dividends per Share/ Price per share
This ratio shows the annual return on an investment through dividends. It helps investors assess the income potential of an investment.
- Market-to-Book Ratio= Market Capitalization/Total Book Value
This ratio compares the market’s valuation of a company to its book value, indicating if the stock is overvalued or undervalued.
