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RATIO ANALYSIS


Mere statistics/data presented in the different financial statements do not reveal the true picture of a financial position of a firm. Properly analyzed and interpreted financial statements can provide valuable insights into a firm’s performance. To extract the information from the financial statements, a number of tools are used to analyse such statements. The most popular tool is theRatio Analysis.

Financial ratios can be broadly classified into three groups: (I) Liquidity  ratios, (II) Leverage/Capital structure ratio, and (III) Profitability ratios.

(I) Liquidity ratios:

Liquidity refers to the ability of a firm to meet its financial obligations in the short-term which is less than a year. Certain ratios, which indicate the liquidity of a firm, are (i) Current Ratio, (ii) Acid Test Ratio, (iii) Turnover Ratios. It is based upon the relationship between current assets and current liabilities.














Quick assets are defined as current assets excluding inventories and prepaid expenses. The acid-test ratio is a measurement of firm’s ability to convert its current assets quickly into cash in order to meet its current liabilities. Generally speaking 1:1 ratio is considered to be satisfactory.


Turnover Ratios:

Turnover ratios measure how quickly certain current assets are converted into cash or how efficiently the assets are employed by a firm. The important turnover ratios are: Inventory Turnover Ratio, Debtors Turnover Ratio, Average Collection Period, Fixed Assets Turnover and Total Assets Turnover

The second set or the coverage ratios measure the relationship between proceeds from the operations of the firm and the claims of out siders.