Ratio Analysis

Ratio analysis is a quantitative analysis of financial statements in order to judge the performance of the company. It expreses the relationship between the items of financial statements. These ratios are calculated to estimate financial performance, for comparision and to identify the ways of improvement. Generally the ratios are categorized into profitability ratio, liquidity ratio, efficiency ratio and solvency ratio.

Profitability ratio indicates the efficiency of earning profit of the company. Example of profitability ratios are gross profit ratio, net profit ratio etc.

Liquidity ratio is calculated in order to know the ability of the company to pay its short term bills. A ratio of greater than 1 is usually minimum because anything less than 1 means the company has more liabilities than assets (Basu, N. D.). Generally, more the liquidity ratio shows more flexibility in the business. Liquidity ratio includes current ratio and quick ratio.

Efficiency ratios are used to analyse how well a company utilizes its assets and liabilities. It includes inventory turnover ratio, receivable turn over and so on.

Solvancy ratio measures the ability of the company to meet the outside liabilities or in another words, it measures that how quickly a company can repay its debts. If solvancy ratio is lower then it shows than the company is in default to pay its debt obligation.

As a consultant we can say, application of all the ratios enables a company to estimate its strengths and weeknesses and ultimately helps them taking corrective actions. Hence we can say that it is a very useful tool to investigate the financial statement.