About Ratio Analysis Formulas
Ratio analysis is a useful tool that we regularly employ in data comparisons between and within businesses. The ratio analysis technique gives numerous useful formulas for a rapid indicator of a company's financial health in various important areas.
What is ratio analysis?
A set of computing and analysis procedures with appropriate formulas is known as ratio analysis. It is divided into four categories:
- Liquidity Ratios
- Profitability Ratios
- Activity Ratios
- Solvency Ratios
Liquidity Ratios
It aids in determining a company's short-term liquidity. There are primarily two types of ratios in it. The first is the current ratio, which indicates a company's short-term solvency.
Current Ratio=CurrentAsset / CurrentLiabilities
The second is the Quick ratio, which can be used to determine solvency for the next six months. The reason for the inventory deduction is that inventory typically takes longer than six months to convert to liquid assets.
Quick Ratio=Totalcurrentratio−Inventory / TotalCurrentLiabilities
Profitability Ratios
The primary goal of any firm is to make money. Profitability is required in every firm. These ratios are used to determine a company's profitability and, as a result, to efficiently quantify success over time. Business owners, taxpayers, stakeholders, government authorities, and others utilise these ratios to determine how well a company is operating. If a company applies for a loan from a bank, the bank will automatically analyse its profitability using these ratios.
Some main ratios covered within this category are:
Activity Ratios
It's also called the turnover ratio, and it gauges a company's efficiency in converting its products into cash. The ratio is expressed as a number of days.
This category includes the following ratios:
Receivables Turnover Ratio=NetCreditSales / AverageTradeReceivable
Solvency Ratios:
The solvency ratio is used to determine if a company can survive in the long run. This ratio can also be used to assess a company's ability to repay long-term debt. The following are the ratios:
(1) Debt-Equity Ratio:The solvency ratio is used to assess a company's long-term viability. This ratio can also be used to determine a business's ability to repay long-term debt. The ratios are as follows:
Debt-Equity Ratio=TotalLiabilities / StakeholdersEquity
(2) Proprietary Ratio:This ratio is used to assess the soundness of a company's capital structure. Diverse businesses have different capital structures, which can range from 50 percent ownership to 50 percent debt. Others, on the other hand, may have 30% equity and 70% debt.
Proprietary Ratio=StakeholdersEquity / TotalAssets×100
- Net Profit Ratio=NetprofitaftertaxX100 / NetSales
- Gross Profit Ratio=GrossProfitX100 / NetSales
- Earnings per share = (NetIncome−PreferredDividend) / WeightedAveragenumberofsharesoutstanding× 100
Inventory Turnover Ratio=Costofgoodssold / AverageInventory
- The inventory turnover ratio tells a company how many times a product is converted into cash in a certain period of time.
- The receivables turnover ratio is used to determine how many times credit is collected in a specific time period.
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