Question

please give an overview of the 5 financial ratios used to analyze the balance sheet and the 5 financial ratios used to analyze the income statement? what does each ratio measure and what valuable information can be derived from the ratio analysis?

Answer 1

Financial ratio used to analyze balance sheet

1) Current Ratio = (Current Asset/ Current liability), it indicates the ability of an enterprise to pay its short term obligation generally within one year; the ideal ratio is 2:1. Greater the ratio indicates greater the ability of the firm to pay its short term obligation.

2) Cash to total asset = (Cash / Total Asset), it depicts the proportion of organization’s asset is in the form of Cash in relation to total asset. Higher the ratio means the enterprise will be able to pay its creditors within time.

3) Debt to Equity ratio = (Debt / Owner's Equity), It measures the total debt of the Organization in relation to its owners’ equity, higher the ratio indicates the enterprise is highly dependent on Borrowed capital, and higher risk to the shareholders.

4) Debt ratio = (Debt / Total asset), higher Debt ratio indicates the company has more risk, debt ratio lower than 1 indicates larger portion of company's asset is funded by equity.

5) Fixed asset to net worth Ratio = (Net fixed asset / Tangible net worth), it depicts how much owners’ equity is invested in the form of fixed asset i.e. Property, plant etc. and the amount available for operation of the enterprise.

Financial Ratio used to analyze income statement

1) Interest Coverage Ratio = (Earnings before interest and tax / Interest Expense), It measures the ability of an enterprise to pay interest on its borrowed funds, higher the ratio, higher its ability to pay.

2) Gross profitability = (Gross profit / Net sales), It shows the margin on sales of an enterprise.

3) Net profitability = (Net profit / Net sales), It measures the overall profitability of an enterprise. Higher ratio may be due to higher gross margin or lower indirect expenses.

4) Price Earnings Ratio = (Market value per share / Earning Per share), It indicates the realtion between Shareholder's earning and investment in the company. it depicts the value of investment in the company as compared to per dollar of income.

5) Earning per share = (Net earnings available to common shareholder / Average outstanding share), It indicates the company's profits per share available to shareholder. higher profit indicates better profitability.