Financial ratios and interpretations, Slides of Accounting

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FINANCIAL RATIOS

MEANINGS

AND

INTERPRETRATIONS

Meaning

Financial ratios are metrics calculated on the basis of

information provided by underlying financial statements.

These are used to understand the financial performance of the

entity.

Different Types of Financial Ratios Liquidity Ratios Solvency Ratios Profit Margin Ratios Activity/Efficiency Ratios Market Ratios

Liquidity Ratios Meaning Ratios used to measure the ability of entity to meet it’s operational requirements and short term obligations. Examples Current Ratio, Quick Ratio, Cash Ratio etc.

Quick Ratio Meaning Quick Ratio is the ratio of quick assets to current liabilities. This ratio is used to assess the availability of highly liquid funds with the entity. Formula Quick Ratio=(Current Assets-Inventory)/Current Liabilities

Cash Ratio Meaning Cash Ratio is the ratio of Cash and Cash Equivalents to current liabilities. This ratio is used to assess the cash position or ease funds available with the entity. Formula Quick Ratio=Cash and Cash Equivalents/Current Liabilities

Debt Equity Ratio Meaning Ratio of long term debt component compared to equity of the entity. This ratio measures whether equity is adequate to cover debt. Formula Debt Equity Ratio=Long term debt/Equity

Debt Ratio Meaning Ratio of total liabilities compared to total assets of the entity. This ratio measures whether assets available are able to cover liabilities. Formula Debt Ratio=Total Liabilities/Total Assets

Profit/Margin Ratios Meaning Ratios used to assess the profitability condition of the entity. Examples Gross Profit Ratio Net Profit Ratio

Gross Profit Ratio Meaning Ratio of Gross Profit compared to total sales of the entity. This ratio measures whether adequate gross profit is available to the entity. Formula Gross Profit Ratio=Gross Profit /Sales * 100

Activity/Efficiency Ratios Meaning Ratios used to assess the capability of assets of the entity to generate revenue or cash. Examples Inventory Turnover Ratio Fixed Assets Turnover Ratio Accounts Receivable Turnover Ratio

Inventory Turnover Ratio Meaning Ratio used to assess capability of inventory of entity to be converted into sales. Formula Inventory Turnover Ratio=Cost of Goods Sold/Average Cost of Inventory

Accounts Receivable Turnover Ratio Meaning Ratio used to assess capability of entity to receive payment in respect of Accounts Receivable. This shows whether the credit policy of the entity is working efficiently. Formula Accounts Receivable Turnover Ratio=Net credit Sales/Average Accounts Receivable

Market Ratios Meaning Ratios used to assess the value of an entity in the eyes of outsiders. Examples P/E Ratio Market to Book Ratio Dividend Yield Ratio