Question

Research, define, describe, and explain the above-mentioned (Minimum 250 words answer for each questions)

List three different types of financial ratios and explain them

Answer 1

There are actually 5 type of financial ratios:

1. Liquidity Ratio

2. Profitability Ratio

3. Leverage Ratio

4. Efficiency Ratio

5. Market Value Ratio

1. Liquidity Ratio:

These ratios are used to determine the ability of the company to meet its short and long term debt obligations. Some of the liquidity ratios are as follow:

a. Current Ratio:

It measures the ability of the company to pay its short term debt.

Current Ratio = Current Assets / Current Liabilities

b. Cash Ratio:

It measures the ability of the company to pay its short term debt with the help of cash and cash-equivalents.

Cash ratio = Cash (and cash equivalents) / Current Liabilities

c. Acid Test Ratio

It measures the ability of the company to pay its short term debt with the help of quick assets ( subtract inventories)

Acid test ratio = (Current assets - Inventories) / Current liabilities.

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2. Profitability Ratio:

It measures the profit of the company and how business is performing in terms of profit.

a. Operating Margin Ratio = Operating Income / Net sales

b. Return on assets (ROA)

It measures/tells how efficiently company is using the available assets for generating profits.

ROA = Net Income / Total Assets

c. Return on equity (ROE):

It measures the ability of company to generate profits by using its equity.

ROE = Net Income / Shareholder's equity

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3. Leverage Ratio:

It tells about the financing of the company i.e. debt and equity

a. Debt to equity ratio = Total Liabilities / Shareholder's equity

b. Debt Ratio: It measures how much assets have been financed by using debt

Debt ratio = Total Liabilities / Total assets

c. Interest Coverage Ratio:

It measures how company is doing in paying back the interest

Interest Coverage Ratio = Operating Income / Interest Expense.