Ratio Analysis : Financial Ratios Essay
Financial ratios help external stakeholders, and enterprise managers know how well or poorly a business is performing and pinpoint areas that could do with improvement. Companies can also compare themselves to the competition or to diverse companies in other industries. Size need not be an issue since ratios standardize accounting relationships to provide management with a raw reckoning of financial status and trends.
To better categorize them, financial ratios are generally divided into seven principal classes:
• LIQUIDITY RATIOS,
• ACTIVITY RATIOS,
• LEVERAGE/CAPITAL STRUCTURE RATIOS,
• COVERAGE RATIOS,
• PROFITABILITY RATIOS,
• MARKET PROSPECTS RATIOS, AND
• EARNINGS QUALITY
Current Ratio gauges the firm’s ability to meet short-term obligations within a given period (usually up to 1 year). It is a measure of Liquidity. The higher your Current Ratio is, the greater your short-term solvency. Although there are several ratios which indicate the liquidity of a company, the Current Ratio can provide us with all the information we need. To be really useful we must compare it over at least three years.
The Current Ratio is the ratio of total Current Assets to total Current Liabilities.
Current Ratio = Current Assets / Current Liabilities
Current assets include cash and bank balances; the inventory of raw materials, work-in-process, and finished goods; marketable securities; borrowers (net of provision for bad and doubtful debts); bills…