7 MAIN CATOGARIES FINANCIAL RATIOS

7 MAIN CATOGARIES FINANCIAL RATIOS

Good day, everyone,

To compare and measure the financial health relationship of an organisation, the financial ratios are developed and used as a yardstick to ascertain its financial position and performance. Here, I will only discuss on what are the financial ratios and its meaning. 

1. LEVERAGE FINANCIAL RATIO

Reflects the percentage of a company’s capital structure that is made up on debt or liabilities owed to external parties, other than shareholders. It tells you the relationship between the internal fund and external debts. This ratio is computed by simply dividing the total debts of the firm by its net worth or total assets.

2. Liquidity Financial Ratios

They are used to judge a firm's ability to meet short term obligations, without disposing its long term assets. The higher the ratio, the greater the ability of the firm to pay its bills. The general and frequent used of these ratios are as follow:-

a. Current Ratio = Current Assets / Current liabilities

b.  Acid-Test Ratio = Current assets less Inventories / Current liabilities

3. Operating Financial Ratios

Reflect the efficiency of the company’s operations in utilizing its resources. This comprise of Inventory Turnover (in term of days); Accounts Receivable Turnover (in term of days); Accounts Payable Turnover (in term of days) and Cash Conversion cycle etc.

4. Profitability In Relation To Sales Financial Ratios

Tell us the profit of the firm relative to sales after deducting the Cost of Good Sold. Here, it indicates the efficiency of operations. Generally, a firm with high gross profit margin is much easier to survive when its operating environment change to its disfavour comparative to those who have razor-thin margins. 

5. Profitability In Relation To Investment 

Relates to investments. One of these measures is the rate of return on common stock equity. This ratio is computed by simply dividing the Net profit after taxes less Preferred stock dividend by its net worth less Par value of preferred stock.

6. Coverage Ratios

Are designed to relate the financial charges of a firm to its ability to service them. One of the most traditional of the coverage ratios is the interest coverage ratio, that is the ratio of earnings before interest and taxes for a particular period to the amount of interest charges for the same period.

7. Solvency Financial Ratios

These financial ratios indicate the chances of a company going bankrupt. The main purpose of this exercise is to ensure that a company is not in danger of going under anytime soon. 

Note that the above yardsticks are frequently used as a ratio, or index, relating two pieces of financial data to each other. You may compare a present ratio with past and expected future ratio for the same company. By doing so, you can determine whether there is an improvement or a deterioration in the firm's financial condition and performance over time.

Trust the above discussion has given you a clear understanding of today's topic. 

Look forward to seeing you again,

James Oh

Skype me at james.oh18