| 1. Liquidity Ratios (LR) | Liquidity ratios assess a company’s ability to meet its short-term obligations and financial stability. Common ratios include the Current Ratio and Quick Ratio. | – Calculate liquidity ratios to determine the company’s short-term liquidity position. – A higher current ratio indicates better short-term solvency. – The quick ratio provides a stricter measure of liquidity by excluding inventory. | – High liquidity ratios suggest the company can easily cover its short-term liabilities. – Low ratios may indicate liquidity problems or an inefficient use of assets. | – Assessing a company’s ability to meet short-term financial obligations. – Evaluating working capital management. | Liquidity Ratios Example: Current Ratio = Current Assets / Current Liabilities. Quick Ratio = (Current Assets – Inventory) / Current Liabilities. |
| 2. Profitability Ratios (PR) | Profitability ratios measure a company’s ability to generate profits relative to its revenues, assets, or equity. Key ratios include Profit Margin, Return on Assets (ROA), and Return on Equity (ROE). | – Calculate profitability ratios to assess the company’s overall profitability. – Profit margin reflects the percentage of profit earned per dollar of revenue. – ROA and ROE evaluate profit generation relative to assets and equity, respectively. | – High profitability ratios indicate effective management and strong financial performance. – Low ratios may signal challenges in generating profits or inefficiencies. | – Assessing the company’s ability to generate profits from its operations. – Comparing profitability to industry peers. | Profitability Ratios Example: Profit Margin = (Net Profit / Revenue) x 100. ROA = (Net Profit / Total Assets) x 100. ROE = (Net Profit / Shareholders’ Equity) x 100. |
| 3. Leverage Ratios (LR) | Leverage ratios measure the extent to which a company relies on debt financing. These ratios help assess the company’s financial risk and its ability to meet interest and principal payments. Common ratios include Debt-to-Equity Ratio and Interest Coverage Ratio. | – Calculate leverage ratios to evaluate the company’s debt levels relative to equity. – A high debt-to-equity ratio indicates significant reliance on debt financing. – The interest coverage ratio assesses the company’s ability to service its interest payments from operating profits. | – Low debt-to-equity ratios suggest lower financial risk and less reliance on debt financing. – High interest coverage ratios indicate the ability to comfortably cover interest expenses. | – Assessing the company’s financial risk and debt management practices. – Evaluating borrowing capacity and creditworthiness. | Leverage Ratios Example: Debt-to-Equity Ratio = Total Debt / Shareholders’ Equity. Interest Coverage Ratio = Earnings Before Interest and Taxes (EBIT) / Interest Expenses. |
| 4. Efficiency Ratios (ER) | Efficiency ratios, also known as activity or turnover ratios, assess how efficiently a company manages its assets and resources to generate sales and cash flow. Common ratios include Inventory Turnover and Accounts Receivable Turnover. | – Calculate efficiency ratios to evaluate the company’s asset management and resource utilization. – Inventory turnover measures how quickly inventory is sold. – Accounts receivable turnover assesses the efficiency of collecting outstanding payments. | – High efficiency ratios indicate effective asset utilization and management. – Low ratios may suggest inventory overstock or challenges in collecting receivables. | – Analyzing the company’s operational efficiency and resource utilization. – Identifying areas for improvement in inventory or receivables management. | Efficiency Ratios Example: Inventory Turnover = Cost of Goods Sold / Average Inventory. Accounts Receivable Turnover = Net Credit Sales / Average Accounts Receivable. |
