Financial Performance Ratios is used to depict the performance of a business. These ratios are derived from the items of a financial statement. To derive a financial ratio, one variable of the financial statement is divided by the other. It illustrates the relationship between two financial variables. A financial ratio is an important tool for small business firms and managers to measure the progress for achieving the targeted goals. Some of the important financial ratios which a firm would like to analyze:
Liquidity Ratio
Liquidity Ratio describes the current ability of the firm to meet its short-term requirement. These ratios measure the availability of cash in an organization.
Current Ratio= Current Assets/Current Liabilities
Current assets include those assets that can be converted to cash within one year. This ratio measures the firm’s short-term solvency.
Quick Ratio= Current Assets- Inventories/Current Liabilities
Also known as Acid Test ratio.
Cash Ratio= Cash + Marketable Securities/Current Liabilities
This ratio indicates the quick requirement of cash to meet the short-term liabilities.
Asset Turnover Ratio
These ratios indicate how efficiently assets of a firm are utilized to generate sales.
Receivables Turnover=Annual Credit Sales/Accounts Receivables
Collection Period=365/Debtors Turnover
The collection period indicates the speed of collection and the quality of a debtor.
Inventory Turnover =Cost of Goods Sold/Average Inventory
This shows the efficiency of the firm in producing and selling its product.
Inventory Turnover Period= 365/Inventory Turnover
Financial Leverage Ratio
These ratios describe the long-term financial position of a company.
Debt Ratio= Total Debt /Capital Employed
This ratio shows the long-term solvency of a firm and gives an idea of interest bearing debt.
Debt-Equity Ratio=Total Debt/Net Worth
This measures the contribution of lenders for each rupee of the owner’s contribution.
Profitability Ratios
Gross Profit Margin= Gross Profit/Sales
Gross Profit margin illustrates how efficient the firm is in producing each unit of a product
Net Profit Margin=Profit After Tax/Sales
Return on Equity=Profit After Tax/Net worth
Financial ratios become meaningful if it is used to examine the trend, industry norm and peer group comparison. It helps to analyze the business operations and also in understanding Stock Market. The current operations can be compared to the past performance by implementing trend analysis. Industry ratios can be compared to the firm’s ratios to know where the company stands in its respective industry. Ratio analysis is a process to identify the strengths and weakness of a firm. It helps to ascertain the financial condition of a company.
