CLASSIFICATION OF RATIOS

Liquidity ratio
Leverage ratio
Activity ratio
Profitability ratio
Coverage ratios
LIQUIDITY RATIOS
Current ratio
Quick ratio/acid test
ratio
Cash ratio
Net working capital
ratio
 Liquidity ratios

•Liquidity refers to the ability of

a firm to meet it its current
obligations as when they
become due.
CURRENT RATIO

Current ratio is the most common

ratio for measuring liquidity. Being
related to working capital analysis, it
is called the working capital ratio. The
current ration is the ration of total
current assets to total current
liabilities.
Current ratio = current assets
Current liabilities
Current assets include cash and those
assets which can be converted into cash
within a year, such as marketable
securities, debtors and inventories,
prepaid expenses are also included.

Current liabilities include creditors, bills

payable, accrued expenses, short term
bank loan, long term debt maturing in
current year.
 Importance of current ratio

A ration of 2:1 is considerably satisfactory

as a rule of thumb. Thus a good current ratio,
in a way, provides a margin of safety to the
creditors. The larger the amount of current
assets in relation to current liabilities, the
more
the firm’s ability to meet its current
obligations.
 Quick ratio/ acid test ratio

•Quick ratio establishes a relationship between

quick, or liquid, assets and current liabilities.
An asset is liquid if it can be converted into
cash is most liquid asset. Other assets which
are considered to be relatively liquid and
include
d in quick assets are book debts (debtors and
bills receivables) and marketable securities
The quick ratio is found out by dividing quick
assets by current liabilities.

Quick ratio = current assets – inventories

Current
liabilities
 Importance of quick ratio

Generally an quick ratio 1:1 is considered to

represent a satisfactory current financial
condition. Although quick ratio is a more
Penetrating test of liquidity than the current
ratio, yet it should be used cautiously.

It should be remembered that all book debts

may not be liquid, and cash may be immediate
needed to pay operating expenses.
Leverage ratios

Debt-equity ratio
Total debt ratio
Proprietary ratio
The solvency ratio
Fixed assets ratio
Debt service ratio
 Debt-equity ratio
This ratio establishes the relationship between
the long-term funds provided by creditors those
provided by the firms owners it is commonly
used to measure the degree of financial leverage
of the firm. It is calculated as follows:

Debt- equity = long-term debts

Shareholder’s equity
Generally, a ratio of 2:1 is considered
satisfactory