Liquidity ratios and activity ratios

Current Ratio Current Assets Current Liabilities Short-term creditors prefer a high current ratio since it reduces their risk. It is important to make this distinction when calculating ratios. The quick ratio is defined as follows: These assets essentially are current assets less inventory.

Direct comparison of financial statements is not efficient due to difference in the Liquidity ratios and activity ratios of relevant businesses. Financial ratios allow for comparisons between companies between different time periods for one company between a single company and its industry average Ratios generally are not useful unless they are benchmarked against something else, like past performance or another company.

The current ratio is the ratio of current assets to current liabilities: The quick ratio expands on the current ratio by only including cash, marketable securities and accounts receivable in the numerator. Net income is always the amount after taxes, depreciation, amortization, and interest, unless otherwise stated.

Common leverage ratios include the following: For example, internal analysis regarding liquidity ratios involves utilizing multiple accounting periods that are reported using the same accounting methods. Financial ratios can be broadly classified into liquidity ratios, solvency ratios, profitability ratios and efficiency ratios also called activity ratios or asset utilization ratios.

Activity ratios are one major category in which a ratio may be classified; other ratios may be classified as measurements of liquidityprofitabilityor leverage. Other categories include cash flow ratios, market valuation ratios, coverage ratios, etc.

The current ratio divides total current assets by total current liabilities. Working capital is the difference between current assets and current liabilities. Typical values for the current ratio vary by firm and industry.

One drawback of the current ratio is that inventory may include many items that are difficult to liquidate quickly and that have uncertain liquidation values.

Because businesses typically operate using materials, inventory, and debt, activity ratios determine how well an organization manages these areas.

Users of financial ratios include parties external and internal to the company: Net profit margin ratio helps find out if a business is more profitable than its peers or for example if its profitability has increased over different periods.

Large multi-national corporations may use International Financial Reporting Standards to produce their financial statements, or they may use the generally accepted accounting principles of their home country. Thus, the ratios of firms in different industries, which face different risks, capital requirements, and competition are usually hard to compare.

Common market value ratios include the following: Financial ratios are categorized according to the financial aspect of the business which the ratio measures.

Receivables Turnover Annual Credit Sales Accounts Receivable The receivables turnover often is reported in terms of the number of days that credit sales remain in accounts receivable before they are collected.

Common efficiency ratios include: Sales reported by a firm are usually net saleswhich deduct returns, allowances, and early payment discounts from the charge on an invoice.

Total credit sales are divided by the average accounts receivable balance for a specific period. Two commonly used asset turnover ratios are receivables turnover and inventory turnover. Uses and Users of Ratio Analysis Ratio analysis serves two main purposes: Purpose and types[ edit ] Financial ratios quantify many aspects of a business and are an integral part of the financial statement analysis.

Financial ratio analysis is very useful tool because it simplifies the process of financial comparison of two or more businesses.

Financial analysts, retail investors, creditors, competitors, tax authorities, regulatory authorities, and industry observers Internal users: There is no international standard for calculating the summary data presented in all financial statements, and the terminology is not always consistent between companies, industries, countries and time periods.Financial Ratios are used to measure financial performance against standards.

Analysts compare financial ratios to industry averages (benchmarking), industry standards or rules of thumbs and against internal trends (trends analysis). Liquidity ratios measure the availability of cash to pay debt.

Financial ratio

Activity ratios measure how quickly a firm converts non-cash assets to cash assets. [3] Debt ratios measure the firm's ability to repay long-term debt.

Financial Ratio Analysis

[4]. Liquidity ratios are also excellent tools for companies to use when performing company self-evaluations. Knowing the correct way to calculate each ratio and what each ratio means is a vital part. Liquidity ratios; Leverage ratios; Efficiency ratios, also known as activity ratios, are used to measure how well a company is utilizing its assets and resources.

Common efficiency ratios include: The asset turnover ratio measures a company’s ability to. Liquidity ratios are a class of financial metrics used to determine a debtor's ability to pay off current debt obligations without raising external. Unlike liquidity ratios that are concerned with short-term assets and liabilities, financial leverage ratios measure the extent to which the firm is using long term debt.

The debt ratio is defined as total debt divided by total assets.

Liquidity ratios and activity ratios
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