Liquidity Ratio
The organization needs to meet the obligation in one year or in the short run. Liquidity ratios can be identified with the relationship between current assets and current liabilities. Some of the important liquidity ratios are Current ratios and Acid test ratios.
Current Ratio
The current Ratio can be defined as Current Assets/Current Liabilities. The organization needs to meet the obligation in one year or in the short run. Liquidity ratios can be identified with the relationship between current assets and current liabilities. Some of the important liquidity ratios are Current ratios and Acid test ratios. The current ratio measures the ability of the company to meet its current liabilities. During the operating cycle, the current asset is converted to cash to pay for the current liabilities. The ratio mentioned is a current asset by current liabilities so the greater a current asset the better short-term solvency. In current assets there is also a section of cash assets part so for high performance of a current asset to current liability ratio the liquidity ratio is high, therefore the general norm is current ratio is 1.33 in India and internationally it could be 2.
Acid Test Ratio
This is also called quick ratio which is defined as Quick Asset/Current Liabilities. This is also called Quick ratio which is defined as Quick Asset/Current Liabilities. The Acid test ratio is also called the Quick ratio as this is the stricter form of measuring the liquid assets. In the Quick Asset, it should exclude the Inventory. The reason for excluding the inventory is because the inventory is one of the least liquid components in the current asset.
Solvency and Leverage Ratio
The Leverage Ratio is the ability of the organization to meet financial obligations using debt or loans. The regulatory body keeps the track of how much leverage the company can take. Some of the common Leverage Ratios are Debt to Equity Ratio and Interest Coverage Ratio. Too much debt can be risky for the organization and stakeholders if there is too much debt the company has taken. The leverage ratio is also called the debt financial ratio. Debt finance is a cheaper source of ratio but it is also one of the risk sources of finance for the organization. The leverage ratio also helps to understand how much risk is taken to finance the investment. There are two types of ratios that are commonly used, one is the structural ratio an example of a structural ratio is the debt to equity ratio and which defines the financial structure of the firm. The second one is the Coverage ratio which shows the relationship of debt commitments of the company to meet the financing goals.
Debt to Equity Ratio
The debt-to-equity ratio tells us how the company is funded by taking debt as compared to the owner’s funds. If the debt-to-equity ratio is lower then higher is the degree of protection or lesser risk taken to fund the company.
The formula for Debt-To-Equity Ratio = Total Liabilities/Shareholder’s Funds
Interest Coverage Ratio
Interest Coverage Ratio is defined as profit before Interest and Taxes with respect to Interest. The profit before interest and tax is called Earnings Before Interest and Tax (EBIT) or Profit Before Interest and Tax (PBIT). If the Interest Coverage Ratio is high, then the ability to pay interest is high. A low-interest coverage ratio means the ability to pay interest is low as profit before interest and taxes are low. The Earning or Profit before interest and tax includes the interest component which needs to be paid as a finance cost for purchasing the debt. The ratio is used by the stakeholders to understand if the company can pay the interest for the debts during bad times. The ratio may be modified to include the lease payment and preference dividends.
So, the formula for Interest Coverage Ratio with only Earning before interest and tax is EBIT/Interest
Interest Coverage Ratio = EBIT/Interest
The modified formula to include fixed payments like depreciation, noncash charges, interest on the term loan and lease rentals which is also called debt service coverage ratio is equals
Modified Debt Service Coverage Ratio = (profit after tax + depreciation + other non cash charges + interest on term loan + lease rental)/ (interest on term loan + lease rental + repayment of term loan.
Turn Over Ratio or Efficiency Ratio or Activity Ratio
The Turnover Ratio or Efficiency Ratio is to measure how efficiently the assets are used by the firm. It is also called the Activity ratio which means how much the company is managing the efficiency of assets. The asset can be inventory assets. Some of the important turnover ratios are the inventory turnover ratio, average collection period, receivable turnover, fixed asset turnover, and total asset turnover.
Inventory Turn-Over Ratio
The ratio of sales from operation with the inventory at the end of 1 year. This indicator shows the efficiency of a company to get the revenue for every unit of inventory. This also tells that the management of the company is either reducing the inventory or increasing the sales. It tells how much the company is able to sell the inventory produced. Sales are nothing but Revenue from Operations. The higher the ratio, the better the efficiency of the management to sell the inventory. There is an exception, if the ratio is higher, there might be a frequent shortage of the stock, which may lead to a loss of sales.
The formula of Inventory Turn Over Ratio = Sales/Inventory.
Another formula is Turn Over Ratio = Revenue from operations/Average Inventory.
Debtors Turn Over Ratio
The Debtors Turn Over Ratio is also called the Receivable Efficiency Ratio. It is the ratio of Net Sales revenue from operations during the period divided by trade accounts receivables or sundry debtors. A high ratio implies either that a company can work on a cash basis or that its collection of trade receivables is efficient. When the ratio is low then the company is not collecting the trade receivable in time and less on sales.
The formula for Debtors Turn Over Ratio = Next Credit Sales/Average Trade Receivables.
Fixed Assets Turn Over Ratio
It is also called the Non-Current assets(Fixed Assets) efficiency ratio. It is the ratio of Sales from Operations divided by non-current assets(Fixed Assets) at the end of that period. Sales from Operations is also called Net Fixed Asset. This ratio explains how the company is efficient in utilizing the fixed asset. The higher the ratio means the company is able to sell the fixed asset or non-current assets efficiently. There is one exception in the case of noncurrent or fixed assets there is depreciation, in that case, the ratio is high as the denominator of the fixed asset is very low.
The formula is Fixed Asset Turn Over Ratio = Sales / Net Fixed Assets.
Total Asset Turn Over Ratio
The Total Asset Turnover Ratio is the ratio of Sales divided by Total Assets. This implies the higher the ratio greater the ability of the company to sell the total assets.
Total Asset Turnover Ratio = Sales/Total Assets
Profitability Ratio
The Probability ratio help in analyzing the performance of a company during the period. Some of the ratios are Net Income ratio, Return on Equity, and Return on Asset are some of the most used Profitability ratios. There are two types of ratios profit margin ratios and rate of return ratios. All the profit margin ratios explain how there is a relationship between profit and sales. Some examples of profit margin ratios are the gross profit margin ratio and net profit margin ratio. The rate of return explains the relationship between profit and investment. It explains how the sales and investment are used to increase the profit.
Gross Profit Margin Ratio
This is Gross Profit Margin Ratio = Gross Profit/Sales
Net Profit Margin Ratio
This is Net Profit Margin divided by Sales.
Return on Assets (ROA)
This is Profit After Tax divided by Total Asset
Earning Power
This is Earning before Interest and Tax(EBIT) divided by Total Assets