Ratio analysis is basically used to understanding the financial health of a business entity. With the help of ratios we can easily calculate from current year performance of the companies and are then compared to previous years. Ratio analysis conducts a quantitative analysis of information in a company’s financial statements. These Ratios are most commonly used in banking sector can be divided into five main categories
Liquidity Ratios
Leverage Ratios
Profitability Ratios
Activity Ratios
Market Ratios
A) Liquidity Ratios
Liquidity Ratios are used to determine a company's ability to meet its short terms obligations.
These include;
1) Current Ratio
2) Acid Test Ratio
3) Working capital
Current Ratio
What Does Current Ratio Mean?
A liquidity ratio that measures a company's ability to pay short-term obligations. Also known as "liquidity ratio", "cash asset ratio" and "cash ratio".
OR
It is a measure of general liquidity and is most widely used to make the analysis for short term financial position or liquidity of a firm. It is calculated by dividing the total of the current assets by total of the current liabilities.
Formula = Current Assets / Current Liabilities
This ratio answer in “Times”
Acid Test Ratio
What Does Acid-Test Ratio Mean?
A stringent indicator that determines whether a firm has enough short-term assets to cover its immediate liabilities without selling inventory.
Also known as the "Acid-test ratio" or the "Quick assets ratio" or “Liquidity ratio”.
OR
An indicator of a company's short-term liquidity. The quick ratio measures a company's ability to meet its short-term obligations with its most liquid assets. The higher the quick ratio, the better the position of the company.
Formula = Current Assets – Inventories – Prepaid Expense / Current Liabilities
OR
Acid Test Ratio = Quick Assets / Current Liabilities
Quick Assets = Current assets - (Stock + Prepaid Expenses)
This ratio answer in “Times”
Working Capital
What Does Working Capital Mean?
A measure of both a company's efficiency and its short-term financial health. Also called “net current assets” or “current capital”.
OR
The cash available for day-to-day operations of an organization. Net liquid assets computed by deducting current liabilities from current assets. The amount of available working capital is a measure of a firm's ability to meet its short-term obligations.
Formula = Current Assets – Current Liabilities
This ratio answer in “Rs”
B) Leverage Ratios
Leverage ratios measure the degree of protection of suppliers of long term funds.
These include:
1) Times Interest Earned
2) Debt Ratio
3) Debt / Equity Ratio
4) Debt to Tangible Net worth Ratio
5) Total Capitalization Ratio
Times Interest Earned
What Does Times Interest Earned - TIE Mean?
A metric used to measure a company's ability to meet its debt obligations. It is calculated by taking a company's earnings before interest and taxes
(EBIT) and dividing it by the total interest payable on bonds and other contractual debt.
OR
The times interest earned ratio indicates the extent of which earnings are available to meet interest payments. The times interest earned ratio is an indicator of a company’s ability to meet the interest payments on its debt.
Formula = Earning Before Income Tax (EBIT) + Interest Expense / Interest Expense
This ratio answer in “Times”
Debt Ratio
What Does Debt Ratio Mean?
A ratio that indicates what proportion of debt a company has relative to its assets. The measure gives an idea to the leverage of the company along with the potential risks the company faces in terms of its debt-load.
OR
Debt ratio indicates the percentage of a company's assets that are provided via debt or liability. Formula = Total Liabilities / Total Assets This ratio answer in “%”
Debt/Equity Ratio
What Does Debt/Equity Ratio Mean?
It indicates what proportion of equity and debt the company is using to finance its assets.
A measure of a company's financial leverage.
Formula = Total Liabilities / Total Shareholder Equity
This ratio answer in “%”
Debt to Tangible Net worth Ratio
What Does Tangible Net Worth Mean?
A measure of the physical worth of a company, which does not include any value derived from intangible assets such as copyrights, patents and
intellectual property. Tangible net worth is calculated by taking a firm's total assets and subtracting the value of all liabilities and intangible assets.
Formula = Total Debt / Tangible Net Worth
Tangible Net Worth = Total Assets – Intangible Assets – Total Liabilities
This ratio answer in “%”
Total Capitalization Ratio
What Does Long-Term Debt To Capitalization Ratio Mean?
The capitalization ratio measures the debt component of a company's capital structure, or capitalization (i.e., the sum of long-term debt liabilities and shareholders' equity) to support a company's operations and growth.
Formula = Long Term Debt / (Long Term Debt + Shareholder Equity)
This ratio answer in “%”
C) Profitability Ratios
Profitability ratios measure the earning ability of a firm. These include:
1) Net Profit Margin
2) Return on Assets
3) DuPont Return on Assets
4) Operating Income Margin
5) Return on Operating Assets
6) Return on Total Equity
7) Gross Profit Margin
Net Profit Margin
What Does Profit Margin Mean?
A ratio of profitability calculated as net income divided by revenues, or net profits divided by sales. It measures how much out of every dollar of sales a company actually keeps in earnings. Profit margin is very useful when comparing companies in similar industries.
Formula = (Net Income / Net Sales) x 100
This ratio answer in “%”
Return on Assets
What Does Return On Assets - ROA Mean?
An indicator of how profitable a company is relative to its total assets. ROA gives an idea as to how efficient management is at using its assets to generate earnings or revenues.
Formula = (Net Income / Total Assets) x 100
This ratio answer in “%”
DuPont Return on Assets
What Does DuPont Identity Mean?
An expression that breaks return on equity (ROE) down into three parts:
profit margin, total asset turnover and financial leverage. It is also known as "DuPont Analysis".
Formula = (Net Income / Sales) x (Sales / Total Assets) x 100
This ratio answer in “%”
Operating Income Margin
What Does Operating Margin Mean?
A ratio used to measure a company's pricing strategy and operating efficiency.
Formula = Earning before Interest and Taxes (EBIT) / Net Sales x 100
This ratio answer in “%”
Return on Operating Assets
The return on operating assets measure only includes in the denominator those assets actively used to create revenue. This focuses management
attention on the amount of assets actually required to run the business, so that it has a theoretical targeted asset level to achieve. A typical result of this measurement is an ongoing campaign to eliminate unnecessary assets.
Formula = Earnings before Interest and Taxes / Operating Assets x 100
OR
Formula = Net Income / Operating Assets x 100
This ratio answer in “%”
Return on Total Equity
What Does Return On Equity - ROE Mean?
The amount of net income returned as a percentage of shareholders equity. Return on equity measures a corporation's profitability by revealing
how much profit a company generates with the money shareholders have invested.
Formula = Net Income / Total Equity x 100
This ratio answer in “%”
Gross Profit Margin
What Does Gross Profit Margin Mean?
The gross profit margin is a measurement of a company's manufacturing and distribution efficiency during the production process. The gross profit tells an investor the percentage of revenue / sales left after subtracting the cost of goods sold.
Formula = Gross Profit / Net Sales x 100
This ratio answer in “%”
D) Activity Ratios
Activity ratios measure a firm's ability to convert different accounts within Their balance sheets into cash or sales. These include:
1) Total Assets Turnover
2) Fixed Assets Turnover
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