What is Ratio Analysis?

Ratio, as the name suggests, is a comparison between two numbers. In Finance, Ratio Analysis refers to a comparison of different items appearing in the books of accounts or financial statements to give a precise and understandable interpretation. The most common interest of most of the stakeholder, including the company itself is to assess the health of a company in terms of its revenue, its liquidity, the efficiency of operations, and profitability.`

How Ratio Analysis can be important for your Business?

Financial statements are generally insufficient to provide information to the readers or stakeholders at first instance on their own; the numbers shown in those statements required to be put into such a form or format so that stakeholders can havea betterunderstanding regarding different aspects of the company’s operations and its health in the expression given by the company. Ratio analysis is one of the methods a stakeholder can use to gain that understanding with. Further, it assists in major decision making for the top management to review lesser data as compared to the entire set of books of accounts.

Types of Ratios Analysis:

Profitability ratios:

It compares the company’s ability to earn or generaterevenue with its expenses so that it can arrive at a desired rate of return and recognise if there is any shortfall. It includes ratios like-

  • Gross Profit Ratio
  • Operating Profit Ratio
  • Net Profit Ratios
  • Interest Coverage Ratio

Liquidity ratios:

It measures the ability of a company to pay its day to day debt on time. It is an important ratio or test to determine the company’s ability to cover short term obligation and cash flow. It includes the ratios like-

  • Current Ratio
  • Working Capital Ratio
  • Quick Ratios etc.

Return on Investment Ratios:

Return on Investment orReturn on Assets measuresthe amount of return on investment concerning the investment cost. It is a broad measure of investment profitability. It includes the ratios like-

  • Return on Equity
  • Return on Assets

Efficiency Ratios or Activity Ratio:

It measures how well a company operate their assets to generate income. It also signifies the time acompany takes to collect cash from the customer or the time it takesto convert inventory into cash that is making sales. It includes the ratios like-

  • Inventory Turnover Ratio
  • Inventory Days
  • Accounts Receivable Ratio
  • Accounts Receivable Days
  • Accounts Payable Ratio
  • Accounts Payable Days
  • Working Capital Turnover
  • Cash Turnover

Solvency Ratios& Leverage Ratios:

It measures the company’s ability to make payments and pay off its long-term obligations to creditors. A balancedsolvency&leverage ratios indicate a more creditworthy and financially sound company in the long-term. It includes the ratios like-

  • Debt to Equity
  • Debt to Capital
  • Debt to Tangible Net Worth
  • Total Liabilities to Equity
  • Total Assets to Equity
  • Debt to EBITDA

Market Ratios:

These ratios help to understand the economic status ofthe stock of a particular public traded company. They determine the connection between the price per share of a company and its earnings, growth and assets, or we can say it helpsin indicating the value of a company. It includes the Ratios like-

  • Dividend Yield
  • Earnings Per Share
  • Price Earnings Ratio

Benefits of Accounting Ratios:

We at Whiz Consulting have accounting experts who are specialised in identifying and calculating ratios and giving you in-depth in understanding your business financial performance.

Simplification of Complex Numbers

The prime benefit of Ratios is - it simplifies complex accounting and Financial data into simple ratios to comprehend what and how the company is performing in terms of its efficiency, solvency, financial efficiency, etc.

Measure Trends in Accounting Ratio

The Ratios calculated over some periods facilitate if there is a trend in the movements of company operations. The ratio analysis report supports the management decision to prepare or approve the budgets for the future based on previous trends.

Facilitates Industry Comparison

The similar Ratios calculated by the companies operating in a similar industry provides a better scope of inter-company comparison. It helps investors as well as the company to assess and review whether they are managing the company efficiently.

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