Ratios can be divided into number of ways according to the purpose and nature of analysis. The ratios for financial analysis of business can be classified into five categories as given below:
Thank you for reading this post, don't forget to subscribe!1. Liquidity Ratios
Liquidity ratios measure a company’s ability to pay off its short-term debts as they become due, using the company’s current or quick assets. Liquidity ratios include the current ratio, quick ratio.
a. Current Ratio or Working Capital Ratio
The current ratio is a measure of a company’s ability to pay off the obligations within the next twelve months. This ratio is used by creditors to evaluate whether a company can be offered short term debts. It also provides information about the company’s operating cycle. It is also popularly known as Working capital ratio. It is obtained by dividing the current assets with current liabilities.
Current ratio is calculated as follows:
Current ratio = Current Assets / Current Liabilities
where,
- Current assets: A current asset, also known as a liquid asset, is any resource a company could use, turn into cash, or sell within a year.
2. Current liabilities: Current liabilities are an enterprise’s obligations or debts that are due within a year or within the normal functioning
b. Quick Ratio or Acid Test Ratio:
Quick ratio is also known as Acid test ratio is used to determine whether a company or a business has enough liquid assets which are able to be instantly converted into cash to meet short term dues. It is calculated by dividing the liquid current assets by the current liabilities
Quick Ratio = (Cash + Marketable securities + Accounts receivable) / Current liabilities
The ideal quick ratio should be one 1 for a financially stable company.
1.Quick Assets: Quick assets refer to assets owned by a company with a commercial or exchange value that can easily be converted into cash or that are already in a cash form.
Quick Assets=Current assets-Inventory-Prepaid expenses
2. Current Liabilities: Current liabilities are an enterprise’s obligations or debts that are due within a year or within the normal functioning
2. Solvency Ratio:
Solvency ratios are a key component of the financial analysis which helps in determining whether a company has sufficient cash flow to manage the debt obligations that are due. Solvency ratios are also known as leverage ratios.