Financial ratios are numerical comparisons of financial statement accounts. By understanding the relationships between the financial statement accounts (Also see How Balance Sheet relate to Profit and Loss?), internal business management, creditors and investors could comprehend how well the company is operating.
Financial ratios are the most prevalent and typical tools in evaluating the financial standing of a company (Also see Capital Budgeting in Business Investments). Ratios are simple to comprehend and easy to calculate. Financial ratios could also be used to compare various business in various industries. Small and big companies can make use of ratios to compare their financial information as a ratio is merely a numerical comparison based on percentages. In other words, financial ratios do not consider the size of the industry or a company. Ratios are simply a raw calculation of financial position and performance of a business. For more advance technique, you may consider engaging an accounting service in Johor Bahru.
Ratios enable us to compare business from different industries, either small or big, and determine their weak points and strengths. Financial ratios can be categorised into seven primary classifications: liquidity, efficiency, solvency, market prospect, coverage, investment leverage and profitability.
Liquidity ratios assess the capability of a business to settle the current liabilities. To put it simply, these ratios indicate a company’s cash levels and other liquid assets’ as a ratio to its current liabilities and other present debts. This helps the management to check if all short term debt are able to be met so they do not allocate too much assets that can only be realised at a longer time frame.
Efficiency ratios, also known as activity ratios, determine how well a business generate income using their assets. Efficiency ratios measure the time for the business to gather money from consumer or the time taken for the companies to turn their stock into money, which is making sales. These ratios are useful to help the management to improve their business and also help the creditors and investors to assess the profitability of the business.
Solvency ratios, or leverage ratios, determine the capability of a business to sustain operations forever by comparing financial obligation levels with assets and equity. To put it simply, solvency ratios measure a company’s capability to pay the bills in the long term and presented in a percentage form, indicating the total liabilities’ proportion out of the aggregate of total liabilities plus equity.
Market Prospect Ratios
The function of market prospect ratios is to make a comparison between publicly traded businesses’ stock prices with incomes and dividend rates. Investors use this ratio to evaluate stock price patterns and find out a stock’s future and present market price.
Coverage ratios determine a business’s capability to pay liabilities. Coverage ratios seem to be similar with solvency and liquidity ratios, yet there is a unique distinction. Coverage ratios evaluate a business’s ability to service its financial obligations in terms of how many times the existing assets is to the liabilities.
Investment Leverage Ratios
Financial leverage ratios, also known as equity or debt ratios, determine the value of equity in business by evaluating its overall financial obligation. These ratios either compare assets to debt or equity along with shares outstanding to determine the real value of the equity in a company.
Profitability ratios make a comparison between Profit and Loss accounts and classifications to reveal a business’s capability in generating profits. Profitability ratios concentrate on a business’s return on investment in stock and other assets. These ratios generally demonstrate how well business could gain profits from their operations.
Here are the seven financial ratios you need to know in managing your business. Talk to an accounting firm in Johor Bahru for more professional advice.