Ratios for analysis and justification for ratio choice

Since a company performance has many metrics, thus it becomes difficult to gauge the
success of company from absolute values. Thus, analysis through comparison and relative
performance becomes imperative. Ratio analysis helps us to solve this problem, by providing
us a framework through which we can analyse a company’s performance over a period of
time and also in different parameters.
Most important parameter while analysing a company’s performance through financial
statements is below
1. Profitability
2. Efficiency
3. Working capital management
4. Liquidity
5. Funding pattern
6. Growth
7. Market based performance
For each of the above there are various ratios that can help us get a sense of how the company
is doing relative to the industry average and also relative to its own past performance that is
whether there is growth or there is contraction. Since there is a plethora of options in ratio
analysis, we have selected 12 amongst them in order to sufficiently do justice in analysing a
company’s performance from a 360 ° point of view. The selected rations are given below
along with the parameter that is being analysed with the ratios.
Profitability Gross Profit Margin, Operating Profit
Margin, Return on Assets and Return on
Equity
Efficiency Fixed Asset intensity Ratio
Working capital Management Net working capital intensity,
operating/Financial Net working capital
intensity ratio
Liquidity Liquidity ratio, Free cash flow yield
Funding Pattern Debt to equity
Growth Revenue growth
Market based Performance Price to earnings ratio
Sufficiency Quick ratio

Free cash flow Yield determines how much of cash we have left to pay dividends and loan
amount. They show the flows of liquidity in the company.
Liquidity ratio -This determines the stock of liquidity present in the company at present in
order to handle short term solvency pressures.
Debt to equity -Funding structure Expresses the Composition of funding through proportion
of debt and equity. It shows the volatility of returns and a potential downside in the returns of
the company. Risk of default in increases with higher debt.

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Working Capital Management Intensity determines how much money is blocked in the
business operations and thus gives important feedback to see if the company my have
solvency issues if net working capital increases over a period of time especially if Financial
Current liabilities is increasing.
Revenue Growth shows if the organisation as a whole is expanding and its activities are
generating better performance as per previous years.
Price to earning ratio -This ratio determines if the company is under-priced or overpriced as
per the industry average and thus gives a signal to shareholder to either sell or buy aa stock of
the company.
Quick ratio -This ratio is a sufficiency test for the company and is also called an acid test.
It’s to check if company needs immediate cash, then can its current assets be disposed off to
manage the current liabilities.
Gross Profit Margin, Operating Profit Margin -These are profitability rations and
determine hoe much gross value is added, what is the nature of handling processing cost,
handling overheads.
Return on Assets and Return on Equity -These ratios show efficiency of management inn
creating profitability through the input of assets and owner’s funds. If the trend is going up
then this makes the company a good buy option.
Fixed Asset intensity Ratio-This ratio determines the bargaining power of the company. If
the ratio is decreasing that means its able to utilise its assets properly and making use of its
fixed assets resourcefully having an edge over competitors thus leading the company to surer
profits. Thus, once can charge more to customer.

Thus by studying and analysing the above ratios we can dissect the financial statements
finding out meaningful information that can be used to make an important business decision
regarding funding ,creating profit or handling costs and operational efficiency .