Professional Documents
Culture Documents
1. Profitability Ratios
These ratios give users a good understanding of how well the
company utilized its resources to generate profit and shareholder
value.
The long-term profitability of a company is vital for its survivability. It
is these ratios that can give insight into the all important "profit".
Return On Assets
This ratio indicates how profitable a company is relative to its total
assets. The return on assets (ROA) ratio illustrates how well
1
a
a
a
a
3. Liquidity ratios
Liquidity ratios attempt to measure a company's ability to pay off its
short-term debt obligations. This is done by comparing a company's
most liquid assets (or, those that can be easily converted to cash)
with its short-term liabilities.
In general, the greater the coverage of liquid assets to short-term
liabilities the better as it is a clear signal that a company can pay its
debts that are coming due in the near future and still fund its
ongoing operations. On the other hand, a company with a low
coverage rate should raise a red flag for investors as it may be a sign
that the company will have difficulty running its operations, as well
as meeting its obligations.
The biggest difference between each ratio is the type of assets used
in the calculation. While each ratio includes current assets, the more
Current Ratio
Current assets
Current liabilities
The quick ratio - or the quick assets ratio or the acid-test ratio - is a
liquidity indicator that further refines the current ratio by measuring
the amount of the most liquid current assets there are to cover
current liabilities. The quick ratio is more conservative than the
current ratio because it excludes inventory and other current assets,
which are more difficult to turn into cash. Therefore, a higher ratio
means a more liquid financial position.
4. Gearing Ratios
Are financial ratios that compare some form of owner's equity (or
capital) to borrowed funds. Gearing is a measure of financial
leverage, demonstrating the degree to which a firm's activities are
funded by owner's funds versus creditor's funds.
Investopedia
explains
Gearing
Ratio
The higher a company's degree of leverage, the more the company is
considered risky. As for most ratios, an acceptable level is
determined by its comparison to ratios of companies in the same
industry. The best known examples of gearing ratios include the
debt-to-equity ratio (total debt / total equity), times interest earned
(EBIT / total interest), equity ratio (equity / assets), and debt ratio
(total debt / total assets).
A company with high gearing (high leverage) is more vulnerable to
downturns in the business cycle because the company must continue
to service its debt regardless of how bad sales are. A greater
8