Ratio Analysis is one of the methods to analyse financial statements. The relationship between various financial factors of a business is defined through ratio analysis. In this article, we have covered various ratio analysis formulas and others in detail.

Ratio Analysis Formulas

Ratio analysis is a quantitative method of gaining insight into a company’s liquidity, operational efficiency, profitability, and solvency by comparing line items in its financial statements. It is a crucial tool used by investors, creditors, and management to evaluate a company’s financial performance.

Key Ratio Analysis Formulas include:

1. Liquidity Ratios
2. Solvency Ratios
3. Activity or Turnover Ratios
4. Profitability or Income Ratios

Liquidity Ratios

The short-term financial position of an enterprise is assessed by liquidity ratios. ‘Liquidity’ refers to the firm’s ability to meet its current liabilities. Liquidity ratios indicate the firm’s ability to meet its current obligations out of the current resources.

Liquidity ratios include:

Current Ratio or Working Capital Ratio

Current Ratio also called Working Capital Ratio is given by the formula:

[Tex]Current~Ratio~=~\frac{Current~Assets}{Current~Liabilities}[/Tex]

Quick Ratio Acid Test Ratio or Liquid Ratio

Quick Ratio also called Acid Test Ratio and Liquid Ratio is given by the formula:

[Tex]Liquid~Ratio=\frac{Liquid~Assets}{Current~Liabilities} [/Tex]

Solvency Ratios

The firm’s ability to meet its long-term liabilities at the time of maturity is computed by solvency ratios. Solvency ratios include:

Debt to Equity Ratio

Debt to Equity Ratio is given by the formula:

[Tex]Debt~to~Equity~Ratio=\frac{Debt}{Equity} [/Tex]

or

[Tex]Debt~to~Equity~Ratio=\frac{Long-term~Loans}{Shareholder’s~Fund~or~Net~Worth} [/Tex]

Total Assets to Debt Ratio

Total Assets to Debt Ratio is given by the formula:

[Tex]Total~Assets~to~Debt~Ratio=\frac{Total~Assets}{Debt} [/Tex]

or

[Tex]Total~Assets~to~Debt~Ratio=\frac{Total~Assets}{Long-term~Loans} [/Tex]

Proprietary Ratio

Proprietary Ratio is given by the formula:

[Tex]Proprietory~Ratio=\frac{Proprietor’s~Fund/Shareholder’s~Fund/Net~Worth}{Total~Assets} [/Tex]

Interest Coverage Ratio

Interest Coverage Ratio is given by the formula:

[Tex]Interest~Coverage~Ratio=\frac{Net~Profit~Before~Interest~and~Tax}{Fixed~Interest~Charges} [/Tex]

Activity Ratios

Activity ratios indicate how efficiently the Working Capital and Inventory are being used to obtain revenue from operations. It indicates the speed or number of times the capital employed has been rotated in the process of doing business. Activity Ratios include:

Inventory Turnover Ratio

Inventory Turnover Ratio also called Stock Turnover Ratio is given by the formula:

[Tex]Inventory~Turnover~Ratio=\frac{Cost~of~Revenue~from~Operations}{Average~Inventory} [/Tex]

Debtors or Receivables Turnover Ratio

Debtors or Receivables Turnover Ratio is given by the formula:

[Tex]Receivable~Turnover~Ratio=\frac{Net~Credit~Revenue~from~Operations}{Average~Receivable} [/Tex]

Creditors or Payables Turnover Ratio

Creditors or Payables Turnover Ratio is given by the formula:

[Tex]Payable~Turnover~Ratio=\frac{Net~Credit~Purchases}{Average~Payable} [/Tex]

Working Capital Turnover Ratio

Working Capital Turnover Ratio is given by the formula:

[Tex]Working~Capital~Turnover~Ratio=\frac{Net~Revenue~from~Operations}{Net~Working~Capital} [/Tex]

Profitability Ratios

The efficiency of any business is measured by the profit earned by the company. Profitability ratios measure the various aspects of the profitability of a company.

Profitability Ratios include:

• General Profitability Ratios
• Overall Profitability Ratios

General Profitability Ratios

Various general profitability ratios are:

Gross Profit Ratio

Gross Profit Ratio is given by the formula:

[Tex]Gross~Profit~Ratio=\frac{Gross~Profit}{Net~Revenue~from~Operations}\times100 [/Tex]

Operating Ratio

Operating Ratio is given by the formula:

[Tex]Operating~Ratio=\frac{Cost~of~Revenue~from~Operations+Operating~Expenses}{Net~Revenue~from~Operations(Net~Sales)}\times100 [/Tex]

Operating Profit Ratio

Operating Profit Ratio is given by the formula:

[Tex]Operating~Profit~Ratio=\frac{Operating~Profit}{Net~Revenue~from~Operations(Net~Sales)}\times100 [/Tex]

Net Profit Ratio

Net Profit Ratio is given by the formula:

[Tex]Net~Profit~Ratio(before~Tax)=\frac{Net~Profit~before~Tax}{Net~Revenue~from~Operations(Net~Sales)}\times100 [/Tex]

[Tex]Net~Profit~Ratio(after~Tax)=\frac{Net~Profit~after~Tax}{Net~Revenue~from~Operations(Net~Sales)}\times100 [/Tex]

Overall Profitability Ratios

Profitability ratios are financial metrics used to evaluate a company’s ability to generate profit relative to its revenue, assets, equity, and other financial metrics. These ratios provide insights into how effectively a company is being managed and its financial health.

Return on Investment is given by the formula:

[Tex]Return~on~Investment~or~Return~on~Capital~Employed=\frac{Net~Profit~before~Interest~and~Tax}{Capital~Employed}\times100 [/Tex]

Summary

Ratio analysis provides valuable insights into various aspects of a company’s financial health, including liquidity, solvency, profitability, efficiency, and market valuation. By understanding and applying these key formulas, stakeholders can make informed decisions about investments, management strategies, and overall financial performance.

Ratio Analysis Formulas-FAQs

What is Ratio Analysis in Finance?

Ratio analysis is a quantitative method used in finance to evaluate a company’s performance and financial health by comparing line items from its financial statements. It involves calculating ratios that provide insights into aspects like liquidity, solvency, profitability, and efficiency.

What are Liquidity Ratios and Why are they Important?

Liquidity ratios measure a company’s ability to meet its short-term obligations. Key liquidity ratios include the current ratio, quick ratio, and cash ratio. They are important because they help assess whether a company has sufficient assets to cover its short-term liabilities, indicating financial stability.

How do you Calculate the Current Ratio?

Current ratio is calculated using the formula:

Current Ratio = (Current Assets)/(Current Liabilities)

What is the Difference Between the Current Ratio and the Quick Ratio?

Current ratio includes all current assets, while the quick ratio (or acid-test ratio) excludes inventory from current assets. The quick ratio is calculated as:

Quick Ratio = (Current Assets – Inventory)/(Current Liabilities)