CLASSIFICATION OF RATIOS

Liquidity ratio Leverage ratio Activity ratio Profitability ratio Coverage ratios

LIQUIDITY RATIOS
Current ratio Quick ratio/acid test ratio Cash ratio Net working capital ratio

Liquidity ratios
•Liquidity refers to the ability of a firm to meet it its current obligations as when they become due.

CURRENT RATIO
Current ratio is the most common ratio for measuring liquidity. Being related to working capital analysis, it is called the working capital ratio. The current ration is the ration of total current assets to total current liabilities. Current ratio = current assets
Current liabilities

Current assets include cash and those assets which can be converted into cash within a year, such as marketable securities, debtors and inventories, prepaid expenses are also included. Current liabilities include creditors, bills payable, accrued expenses, short term bank loan, long term debt maturing in current year.

Importance of current ratio
A ration of 2:1 is considerably satisfactory as a rule of thumb. Thus a good current ratio, in a way, provides a margin of safety to the creditors. The larger the amount of current assets in relation to current liabilities, the more the firm’s ability to meet its current obligations.

Quick ratio/ acid test ratio

•Quick ratio establishes a relationship between quick, or liquid, assets and current liabilities. An asset is liquid if it can be converted into cash is most liquid asset. Other assets which are considered to be relatively liquid and include d in quick assets are book debts (debtors and bills receivables) and marketable securities

The quick ratio is found out by dividing quick assets by current liabilities. Quick ratio = current assets – inventories Current liabilities

Importance of quick ratio
Generally an quick ratio 1:1 is considered to represent a satisfactory current financial condition. Although quick ratio is a more Penetrating test of liquidity than the current ratio, yet it should be used cautiously.

It should be remembered that all book debts may not be liquid, and cash may be immediate needed to pay operating expenses.

Leverage ratios
Debt-equity ratio Total debt ratio Proprietary ratio The solvency ratio Fixed assets ratio Debt service ratio

Debt-equity ratio
This ratio establishes the relationship between the long-term funds provided by creditors those provided by the firms owners it is commonly used to measure the degree of financial leverage of the firm. It is calculated as follows:

Debt- equity = long-term debts Shareholder’s equity Generally, a ratio of 2:1 is considered satisfactory

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