Ratio analysis is a quantitative analysis of financial information that converts quantities into ratios in order to allow businesses to make meaningful comparisons between their own successes and that of the competition. Ratio analysis can help business owners and financial managers evaluate various aspects of a company’s financial performance. There are several types of ratios used in ratio analysis, and each one has a specific purpose. To learn more about the most common types of ratios used for this financial evaluation, see our list below.
Liquidity ratios focus on a company’s ability to pay its short-term debts. The current ratio and the quick ratio are the two most commonly used forms. The quick ratio, also known as the acid test, analyzes how much money is available in the nearest term to pay back obligations immediately, while the current ratio is calculated by dividing a company’s current assets by its current liabilities. These types of ratios are essential for understanding the overall financial health of an organization.
Performance ratios, as you can probably guess, provide a means for measuring the overall performance of a company. These calculations include a book value per common share ratio, cash return on assets ratio, vertical analysis ratio, dividend payout ratio, earnings per share ratio, gross profit margin ratio, price/earnings ratio and more. These calculations are arguably the most comprehensive and thus the most crucial for any business to become familiar with.
Profitability ratios, as the name suggests, are ratios that measure how well a company is profiting from a variety of outlets. This can include efficiency in generating sales, total assets and stockholder’s investments. Some of the ratios included under this umbrella term are the gross profit margin ratio, the return on equity ratio and the return on total assets ratio. Understanding these figures will help to improve any cash flow problems your business may be experiencing.
Debt-equity ratios are calculated by adding outstanding debt, both long and short-term, and dividing it by the book value of shareholder’s equity. This is also known as external to internal equity ratio. It compares outsider’s funds to shareholder’s funds.
Efficiency ratios measures how well a firm uses its assets to produce sales. These types of ratios include the asset efficiency ratio, inventory turnover ratio, receivables turnover ratio and fixed asset turnover ratio. The efficiency ratios are particularly useful as they can help provide a dynamic view of the management and success of an organization, just as margin equity helps identify lucrative investment opportunities.
Market Value Ratios
Market value ratios are calculated for publicly traded companies in relation to stock price. They show the value that has been created for shareholders. Furthermore, this includes a price/earnings ratio, a market to book ratio and a dividend payout ratio. This type of ratio helps to determine if a company’s share is over-priced or under-priced.
Proprietary ratios are used to evaluate the soundness of the capital structure of a company. This means that this ratio can evaluate the amount of capital that is being used to support a business. It is also known as an equity ratio because it analyzes the shareholder’s equity over the total amount of a business’ assets. These Excel database functions are a good indicator of an organization’s financial stability.
Ratio analysis is a technical term for comparing a series of calculations in order to determine a company’s financial standing. These six ratios are the most common types that can be found in ratio analysis. It is important to know these basic ratios when evaluating our business funds.
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