Financial Ratio - Meanings, Types, Ratios & Indicators

 

Financial Ratio

Financial ratio or accounting ratio can be well defined as a ratio of two selective statistical value taken from the financial statements of a business enterprise. Ratio analysis is one of the techniques of financial analysis that determines the relationship between accounting figures and presenting the relationship for the purpose of interpretation so that a conclusion may be drawn. 

Categories

Profitability Ratio :  These ratios are computed to  judge the profitability of the concern. These ratios highlights the result of the business activities. Profitability is an indication of the efficiency with which the operations of the business are carried out. Poor operation performance may indicate poor sale hence poor profits.

Turnover Ratios : These ratios indicate the efficiency with which the capital employed is rotated in the business. Higher the rate of rotation higher will be the profit. Higher turnover ratio means the better use of resources.

Liquidity Ratios : These ratios are computed to judge the short term solvency of the business that is, the ability of the firm to pay its short term creditors. 

Solvency Ratios : These ratios are computed to judge the long term financial position of the business. Solvency means the ability of the firm to pay off its long term creditors. 

TABLE

PROFITABILITY RATIO

Ratios	Formulas	Indicators
Gross Profit Ratio	Gross profit / Sales	Basic Profitability
Operating Profit ratio	Operating profits / Sales	Operating performance of the business
Net Profit Ratio	Net Profit / Sales	Overall Profitability
PV Ratio	Contribution / Sales	Profitability in marginal costing
ROI or ROCE	Total earning / Total capital employed	Overall profitability of the business. Returns on capital employed.  Comparison of ROCE with rate of interest debt leads to financial leverage.
ROE	Earning after tax / Net worth	Profitability of equity funds invested in the business.
EPS	PAT – PD / No. of equity shares	Return per share
DPS	Dividends / No. of equity shares	Profit distributed per share

TURNOVER(PERFORMANCE) RATIO

Ratios	Formulas	Indicators
Fixed Asset Turnover Ratio	Turnover / Net Fixed Asset	Capability to generate sales per rupee working capital
Capital Turnover Ratio	Sales / Capital Employed	Ability to generate sales per rupee of investment.
Working Capital Turnover Ratio	Net Sales / Net Working Capital	Ability to generate sales per rupee of working capital
Stock Turnover Ratio	Cost of goods sold / Average Stock	Indicates how quickly the inventory is used up.
Debtor’s Turnover Ratio	Credit Sales / Average Accounts Receivable	Measure how effective a company is in extending credit as well as collecting debts.
Creditor’s Turnover Ratio	Credit Purchase / Average Accounts Payable	Speed of payment of dues in cash of credit purchase.

LIQUIDITY RATIO

Ratios	Formulas	Indicators
Current Ratio	Current Asset / Current Liability	Availability of current asset to meet current liability. High ratio is the availability of surplus fund. Low ratio is the availability of deficit fund
Quick Ratio	Quick Assets / Quick Liability	Availability to meet immediate liability.
Absolute cash Ratio	Cash+ Marketable Securities / Current Liabilities	Availability of cash to meet short term commitments.

SOLVENCY RATIO

Ratios	Formulas	Indicators
Equity to total fund ratio	Shareholder’s fund / Total Fund	Long term solvency Extent of own fund used in operations
Fixed assets to long term fund ratios	Fixed Assets / Long term funds	Indicate the fixed assets financed by long term loans
Debt Equity Ratios	Debt / Equity	Relationship between debt and equity
Proprietary ratio	Proprietary Fund / Total Asset	The amount of owner’s fund used in financing the assets.
Capital Gearing Ratio	Fixed Charge Bearing capital / Equity Shareholder’s Funds	Represent the financial risk of a company Capital gearing is 3.0 mean the company has debt thrice as much as its equity.