Accounting Ratio : A Ratio is simply one number expressed in relation to another and a study of the relationship between various items or groups of items is known as “Ratio Analysis” . It simplifies and summarizes a Long Array of Accounting Data to provide Useful Information regarding the Liquidity, Solvency, Profitability etc.
Methods or Classification of Ratio Analysis :
(i) Liquidity Ratio : “Liquidity” refers to the Ability of the Firm to meet its Current Liabilities. The Liquidity Ratios therefore are also called “Short Term Solvency Ratios”. These Ratios are used to Assess the Short Term Financial Position of the Concern . They indicate the Firm’s Ability to meet its Current Obligations out of Current Resources.
Liquid Assets = Current Assets – (Inventory + Prepaid Expenses)
(ii) Solvency Ratio : These Ratios are Calculated to Assess the Ability of the Firm to meet its Long Term Liabilities As and When they become Due. These Ratios Reveal as to How much amount in a Business has been Invested by Proprietors and How much amount has been Raised from Outside Sources. Solvency Ratios Disclose the Firm’s Ability to meet the Interest Costs Regularly and Long Term Indebtedness at Maturity.
Interest Coverage Ratio = Pr ofit Before Charging Interest and Income Tax/Fixed Interest Charges
(iii) Activity Ratio : These Ratios are calculated on the basis of “Cost of Revenue from Operations” or “Revenue from Operations”, therefore these Ratios are also called as “Turnover Ratios”. Turnover indicates the Speed or Number of Times the Capital Employed has been Rotated in the Process of doing Business.
Working Capital = Current Assets – Current Liabilities
(iv) Profitability Ratios or Income Ratios : The main object of all the Business Concers is to Earn Profit . Profit is the Measurement of the Efficiency of the Business. Profitability Ratios measures the various aspects of the Profitability of a Company such as : “What is the Rate of Profit on Revenue from Operations” ; “Whether the Profits are Increasing or Decreasing.
