Ratio Analysis Types

Top 5 Types of Ratio Analysis

Ratio Analysis is done to analyze the Company’s financial and trend of the company’s results over a period of years where there are mainly five broad categories of ratios like liquidity ratios, solvency ratios, profitability ratios, efficiency ratio, coverage ratio which indicates the company’s performance and various examples of these ratios include current ratio, return on equity, debt-equity ratio, dividend payout ratio, and the price-earnings ratio.

The numerator and denominator of the ratio to be calculated are taken from the financial statements, thereby expressing a relationship with each other.

It is a fundamental tool that is used by every company to ascertain the financial liquidity, the debt burden, and the profitability of the company and how well it is placed in the market as compared to the peers.

Top 5 Types of Ratio Analysis

There are different types of ratios analysisRatios AnalysisRatio analysis is the quantitative interpretation of the company's financial performance. It provides valuable information about the organization's profitability, solvency, operational efficiency and liquidity positions as represented by the financial statements.read more that have been calculated by every company to evaluate business performance. Simply we may divide it as below:

Ratio Analysis Types

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Source: Ratio Analysis Types (wallstreetmojo.com)

Type #1 – Profitability RatiosProfitability RatiosProfitability ratios help in evaluating the ability of a company to generate income against the expenses. These ratios represent the financial viability of the company in various terms.read more

This type of ratio analysis suggests the Returns that are generated from the Business with the Capital Invested.

Gross Profit Ratio
Gross Profit margin - Ratio Analysis colgate

It represents the operating profit of the company after adjusting the cost of the goods that are sold. The higher the gross profit ratio, the lower the cost of goods soldCost Of Goods SoldThe cost of goods sold (COGS) is the cumulative total of direct costs incurred for the goods or services sold, including direct expenses like raw material, direct labour cost and other direct costs. However, it excludes all the indirect expenses incurred by the company.read more, and the greater satisfaction for the management.

Gross Profit Ratio Formula = Gross Profit/Net Sales*100.
Net Profit Ratio
Net Profit Margin - Ratio Analysis Colgate

It represents the overall profitability of the company after deducting all the cash & no cash expenses: the higher the net profit ratio, the higher the net worthNet WorthThe company's net worth can be calculated using two methods: the first is to subtract total liabilities from total assets, and the second is to add the company's share capital (both equity and preference) as well as reserves and surplus.read more, and the stronger the balance sheet.

Net Profit Ratio Formula = Net Profit/Net Sales*100
Operating Profit Ratio
Operating Profit Margin - Ratio Analysis - Colgate

It represents the soundness of the company and the ability to pay off its debt obligations.

Operating Profit Ratio Formula = Ebit/Net sales*100
Return on Capital Employed

ROCEROCEReturn on Capital Employed (ROCE) is a metric that analyses how effectively a company uses its capital and, as a result, indicates long-term profitability. ROCE=EBIT/Capital Employed.read more represents the profitability of the company with the capital invested in the business.

Return on Capital Employed Formula = Ebit/Capital Employed

Type #2 – Solvency Ratios

These ratio analysis types suggest whether the company is solvent & is able to pay off the debts of the lenders or not.

Debt-Equity Ratio
Pepsi Debt to Equity Ratio

This ratio represents the leverage of the company. A low d/e ratio means that the company has a lesser amount of debt on its books and is more equity diluted. A 2:1 is an ideal debt-equity ratio to be maintained by any company.

Debt Equity Ratio Formula = Total Debt/Shareholders Fund.

Where, total debt = long term + short term + other fixed payments shareholder funds = equity share capital + reserves + preference share capital – fictitious assets.

Interest Coverage Ratio
interest-coverage-ratio

It represents how many times the company’s profits are capable of covering its interest expense. It also signifies the solvency of the company in the near future since the higher the ratio more comfort to the shareholders & lenders regarding servicing of the debt obligations and smooth functioning of the business operationsBusiness OperationsBusiness operations refer to all those activities that the employees undertake within an organizational setup daily to produce goods and services for accomplishing the company's goals like profit generation.read more of the company.

Interest Coverage Ratio Formula = Ebit/Interest Expense

Type #3 – Liquidity Ratios

These ratios represent whether the company has enough liquidity to meet its short term obligations or not. Higher liquidity ratios more cash-rich the company.

Current Ratio
Figure 1 current ratio

It represents the liquidity of the company in order to meet its obligations in the next 12 months. Higher the current ratio,Current Ratio,The current ratio is a liquidity ratio that measures how efficiently a company can repay it' short-term loans within a year. Current ratio = current assets/current liabilities read more the stronger the company to pay its current liabilities. However, a very high current ratio signifies that a lot of money is stuck in receivables that might not realize in the future.

Formula = Current Assets / Current Liablities

Quick Ratio
Liquidity - Quick Ratio

It represents how cash-rich is the company to pay off its immediate liabilities in the short term.

Quick Ratio Formula = Cash & Cash Equivalents+Marketable Securities+Accounts Receivables/Current Liabilities

Type #4 – Turnover Ratios

Theses ratios signify how efficiently the assets and liabilities of the company are used to generate revenue.

Fixed Assets Turnover Ratio
Net Fixed Asset Turnover - Ratio Analysis - Colgate 1

Fixed asset turnoverFixed Asset TurnoverThe fixed asset turnover ratio formula determines the ability of a business entity to generate revenue by employing its fixed assets. It is computed as the fraction of net sales and average net fixed assets.read more represents the efficiency of the company to generate revenue from its assets. In simple terms, it is a return on the investment in fixed assets. Net SalesNet SalesNet sales is the revenue earned by a company from the sale of its goods or services, and it is calculated by deducting returns, allowances, and other discounts from the company's gross sales.read more = Gross Sales – Returns. Net Fixed Assets = Gross Fixed Assets –Accumulated Depreciation.
Average Net Fixed Assets = (Opening Balance of Net Fixed Assets + Closing Balance of Net Fixed Assets)/2.

Fixed Assets Turnover Ratio Formula = Net Sales / Average Fixed Assets
Inventory Turnover Ratio
Inventory Turnover Ratio Analysis - Colgate

The Inventory Turnover RatioInventory Turnover RatioInventory Turnover Ratio is a measure to determine the efficiency of a Company concerning its overall inventory management. To calculate the ratio, divide the cost of goods sold by the gross inventory. read more represents how fast the company is able to convert its inventory into sales. It is calculated in days signifying the time required to sell the stock on an average. The average inventory is considered in this formula since the inventory of the company keeps on fluctuating throughout the year.

Inventory Turnover Ratio Formula = Cost of Goods Sold/Average Inventories
Receivable Turnover Ratio
Receivable Turnover - Ratio Analysis Colgate 1

Receivables Turnover Ratio reflects the efficiency of the company to collect its receivables. It signifies how many times the receivables are converted to cash. A higher receivable turnover ratio also indicates that the company is collecting money in cash.

Receivables Turnover Ratio Formula = Net Credit Sales/Average Receivables

#5 – Earning Ratios

This ratio analysis type speaks about the returns that the company generates for its shareholders or investors.

P/E Ratio
PE Ratio - Google Apple

PE RatioPE RatioThe price to earnings (PE) ratio measures the relative value of the corporate stocks, i.e., whether it is undervalued or overvalued. It is calculated as the proportion of the current price per share to the earnings per share. read more represents the earnings multiple of the company, the market value of the shares based on the pe multiple. A high P/E Ratio is a positive sign for the company since it gets a high valuation in the market for m&a opportunity.

P/E Ratio Formula = Market Price per Share/Earnings Per Share
Earnings Per Share

Earnings Per ShareEarnings Per ShareEarnings Per Share (EPS) is a key financial metric that investors use to assess a company's performance and profitability before investing. It is calculated by dividing total earnings or total net income by the total number of outstanding shares. The higher the earnings per share (EPS), the more profitable the company is.read more represents the monetary value of the earnings of each shareholder. It is one of the major components looked at by the analyst while investing in equity marketsEquity MarketsAn equity market is a platform that enables the companies to issue their securities to the investors; it also facilitates the further exchange of these stocks between the buyers and sellers. It comprises various stock exchanges like New York Stock Exchange (NYSE).read more.

Return on Net Worth

It represents how much profit the company generated with the invested capitalInvested CapitalInvested Capital is the total money that a firm raises by issuing debt to bond holders and securities to equity shareholders. Invested Capital Formula = Total Debt (Including Capital lease) + Total Equity & Equivalent Equity Investments + Non-Operating Cash read more from equity & preference shareholders both.

Return on Net Worth Formula = Net Profit/Equity Shareholder Funds. Equity Funds = Equity+Preference+Reserves -Fictitious Assets.

Conclusion

The above mentioned are some of the ratios analysis types that can be used by the company for its financial analysis. In this way, ratio analysis is a very important tool for any kind of strategic business planning by the top management of the company.

Recommended Articles

This article has been a guide to Ratio Analysis Types. Here we discuss the top 5 types of ratio analysis, including profitability ratios, solvency ratios, liquidity ratios, turnover ratios, and earnings ratios, etc. You can learn more about financing from the following articles –

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  1. Dinesh Berdiya says

    I will keep learning

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