Ratio Analysis is a tool widely used by the financial world. In finance, ratio analysis helps in analyzing the financial health of a company. It is an easy and scientific tool to measure and compare companies across the globe.
There are various types of ratios to measure particular aspect of the performance of the company. Let us look at each one:
Profitability Ratios:
These ratios measure the profitability of the company. Various Profitability ratios are Net profit margin and Gross profit margin.
Return on Investment Ratios:
These ratios measure the return on the investment made in the company. Various return on investment ratios are Return on Equity (ROE), Return on Assets (ROA), Return on Capital Employed (ROCE) and Earning Per Share (EPS).
Short Term Liquidity Ratios:
These ratios measure the liquidity of the company. The widely used liquidity ratio is Current Ratio. Quick Ratio (Acid-test Ratio) and Cash Ratio are also used to measure the liquidity.
Long Term Liquidity / Leverage Ratios:
These ratios measure the long term sustainability of the company. Debt-Equity ratio is one of the most popular ratios for measuring the long term liquidity and the leverage position of the company.
Management Efficiency Ratios:
These ratios measure the efficiency of the management of the company in day to day operations. Various efficiency ratios are Inventory turnover, Receivables turnover, Payables turnover and the length of operating and cash cycle.
Market Ratios:
These ratios helps in understanding the market price of the company and the movements in the same. Various market ratios are P/E Ratio, Dividend Yield, Payout Ratio, Price to Book Value Ratio, etc.
All the above ratios are a good indicator of the aspect they are measuring, but an analyst need to consider all the ratios simultaneously and should also compare with the competing companies in the same industry before reaching to any conclusion.
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