it is need for analyzing the performance of companies

1. Ratio analysis
Introduction:
Ratio analysis is a quantitative analysis of information contained in a company financial
statement. Financial statement includes Balance sheet, profit and loss account, Cash flow
statement, and notes to accounts. It is used to evaluate companies operating and financial
performance such as its efficiency, liquidity, profitability and solvency. The trend of these ratios
over time is studied to check whether the performance of the company is improving or
deteriorating.
Types of financial ratios:
Financial ratios are categorized into:
1. Liquidity ratios
2. Coverage ratios
3. Solvency ratios
4. Efficiency ratios
5. Profitability ratios
Liquidity ratios:
It is a measure of how well the company will be able to meet its short term obligations or
liabilities.
1. Current ratio:
The ratio measures a firm’s ability to pay off its short term liabilities with current
assets. A higher current ratio is always favorable because it shows that the company can
easily make payments for its short term obligations. If an investment decision has to be
made on the basis of current ratio. It can be calculated by using the following formula.
 Current Asset/ Current Liabilities
2. Quick ratio:
It is measure of how well the company will be able to meet its short term liabilities
with quick assets. Quick assets are those current assets which can be converted into cash
within a period of 90 days. It can be calculated by using following formula.
 Quick Assets/Current Liabilities
3. Working capital:
It is the amount to turn to run the day to day business activities efficiency. It is the
amount which the company would like to maintain with itself to meet its day to day
financial obligations. It can be calculated by using the following formula.

2.  Current Assets-Current Liabilities
Coverage Ratios:
Coverage ratio measures how well the company is able to serve its debit.
1. Interest coverage ratio:
It measures how well a company is able to meet its interest obligation in
comparison to meet its operating income. A higher ratio means the company is able to
meet its interest obligations with ease. It can be calculated by using the following
formula.
 EBIT / Interest Expenditure
2. Debt service coverageratio:
It measures how well a company is able to meet its interest as well as principle re-
payment with the operating income. Higher the ratio, better is the position of
company, if it wants to go for further expansion it will be able to take debit as its
source of capital. It can be calculated by using the following formula.
 Profit after tax + depreciation + other non-cash
expenditure +interest on term loan
Interest expenditure + principle repayment
Solvency ratio:
Solvency ratio can measure whether a company will be able to meet its short-term and long
term liabilities.
1. Debt Ratio:
It measures the amount of assets being financed by debt. It also shows the ability of
the company to pay off its debt by selling its assets, in the long term, if the company is
unable to meet its interest cost and principal repayment. It can be calculated by using the
following formula.
 Total Liabilities/Total Assets
2. Equity ratio:
It measures the amount of assets being financed by the owners of the company. A
higher ratio shows the potential creditors of the company that it is less risky and more
suitable to lend to. It can be calculated by using the following formula.
 Total Equity /Total Assets
3. Debt Equity Ratio:

3. It measures the percentage of amount that is being financed by the company
creditors and investors used to invest into the assets of the company. A higher ratio is
viewed as risky as it shows that the investors haven’t funded the operations as much as
creditors have. It can be calculated by using the following formula.
 Total Liabilities / Total shareholder’s equity.
Efficiency Ratios:
It can be used for how to measures the company utilizes assets to generate income.
1. Working capital ratio:
It measures the company’s ability to pay off its current liabilities with current assets. It
can be calculated by using the following formula.
 Current Assets /Current Liabilities
2. Inventory turnover ratio:
It measures how many times average inventory is sold during a period. This shows the
company does not overspend by buying too much inventory and waste resources by storing
non- salable inventory. It also shows that the company can effectively sell the inventory it
buys. It can be calculated by using the following formula.
 Cost of Goods Sold / Average Inventory
3. Debtors Turnover Ratio:
It measures how many times a company can convert its debtors into cash during a period.
A higher ratio shows higher efficiency on the part of the company from a cash flow
standpoint of view. This ratio will helpful to the company to understanding the working
capital requirement. It can be calculated by using the following formula.
 Net Credit Sales / Average debtors
4. Assets Turnover Ratio:
It measures how efficiently the company is able to use it assets to generate sales. A
higher ratio shows that the company is using its assets efficiently. It can be calculated by
using the following formula.
 Net Sales/Average Total Assets
Profitability ratios:
It measures the company’s ability to generate profit from its operations.
1. Gross Profit Ratios:
It measures how profitable is a company when it sells its inventory. Higher the ratio
better will be the profit margin for the company to cover all other types of expenditures

4. such as administrative and selling and distribution expenditure. It can be calculated by
using the following formula.
 Gross Profit/ Net Sales
Gross profit=Sales – Cost of manufacturing a product.
2. Net Profit Ratio:
It measures how well a company manages its expenses relative to its net sales. It
can be calculated by using the following formula.
 Net Profit / Net Sales
3. Return on capital employed:
It measures how efficiently a company can generate profits from its capital
employed. A higher ratio would indicate that more amounts of profits are generated for
every rupee of capital employed.
 Net operating profit / Capital employed
4. Return on equity:
It measures the firm’s ability to generate profit from shareholder’s investment. It
can be calculated by using the following formula.
 Net Income / Shareholders Funds