Financial ratios are grouped into the following categories: Liquidity ratios. Leverage ratios. Efficiency ratios.
The common financial ratios every business should track are 1) liquidity ratios 2) leverage ratios 3)efficiency ratio 4) profitability ratios and 5) market value ratios.
Ratios are classified into two types namely traditional classification and functional classification. The traditional classification is based on the financial statement to which the determinants belong.
Key Takeaways
Ratios include the working capital ratio, the quick ratio, earnings per share (EPS), price-earnings (P/E), debt-to-equity, and return on equity (ROE). Most ratios are best used in combination with others rather than singly to accomplish a comprehensive picture of a company's financial health.
Return on equity ratio
This is one of the most important financial ratios for calculating profit, looking at a company's net earnings minus dividends and dividing this figure by shareholders equity. The result tells you about a company's overall profitability, and can also be referred to as return on net worth.
Ratios compare two numbers, usually by dividing them. If you are comparing one data point (A) to another data point (B), your formula would be A/B. This means you are dividing information A by information B. For example, if A is five and B is 10, your ratio will be 5/10.
The accounting ratios or ratios in management accounting have four ratios: liquidity ratios, activity ratios, solvency ratios, and profitability ratios.
Like fractions, ratios can often be simplified. To simplify a ratio, divide all parts of the ratio by their highest common factor. For example, the highest common factor of both parts of the ratio 4:2 is 2 , so 4:2=2:1 4 : 2 = 2 : 1 .
Ratio analysis is referred to as the study or analysis of the line items present in the financial statements of the company. It can be used to check various factors of a business such as profitability, liquidity, solvency and efficiency of the company or the business.
The most important aspect of ratio analysis is that it makes it easy to understand the actual financial performance and position of the company that cannot be reliably measured by merely looking at the financial statements of the company.
For example, if there is 1 boy and 3 girls you could write the ratio as: 1 : 3 (for every one boy there are 3 girls) 1 / 4 are boys and 3 / 4 are girls. 0.25 are boys (by dividing 1 by 4)
The four-fifths rule is a guideline used to determine if there is adverse impact in the selection process of a specific group. The rule states that the selection ratio of a minority group should be at least four-fifths (80%) of the selection ratio of the majority group.
The profitability ratios often considered most important for a business are gross margin, operating margin, and net profit margin.
Take a look at the three main rules of accounting: Debit the receiver and credit the giver. Debit what comes in and credit what goes out. Debit expenses and losses, credit income and gains.
Accountants use these ratios to measure a business's earnings versus its expenses. These are some common profitability ratios: Return on assets = net income ÷ average total assets. The return-on-assets ratio indicates how much profit companies make compared to their assets.
For example, a 10:1 ratio means you mix 10 parts water to 1 part chemical. The amount of each liquid changes depending on the ratio used, and the size of the container.
Most analysts prefer would consider a ratio of 1.5 to two or higher as adequate, though how high this ratio depends upon the business in which the company operates. A higher ratio may signal that the company is accumulating cash, which may require further investigation.
A general rule of thumb is to have a current ratio of 2.0. Although this will vary by business and industry, a number above two may indicate a poor use of capital. A current ratio under two may indicate an inability to pay current financial obligations with a measure of safety.
It is computed by dividing current assets by current liabilities. A company enjoying good financial health should obtain a ratio around 2 to 1. An exceptionally low solvency ratio indicates that the company will find difficulties in paying its short-term debts.