What is Ratio Analysis?
Ratio analysis is a financial tool that uses mathematical calculations to evaluate a company's
financial performance. It involves comparing different line items from a company's financial
statements (income statement, balance sheet, and cash flow statement) to gain insights into its
profitability, liquidity, solvency, and efficiency.
Why is Ratio Analysis Important?
Ratio analysis is crucial for various stakeholders, including:
Investors: To assess a company's investment potential and risk.
Creditors: To evaluate a company's ability to repay loans.
Management: To monitor performance, identify areas for improvement, and make
informed decisions.
Types of Ratios
Ratio analysis categorizes financial ratios into several main types:
1. Profitability Ratios:
oGross Profit Ratio: Measures the profitability of a company's core
operations.
Formula: Gross Profit / Net Sales x 100
oNet Profit Ratio: Measures the overall profitability of a company after all
expenses.
Formula: Net Profit / Net Sales x 100
oReturn on Equity (ROE): Measures the return generated for shareholders.
Formula: Net Income / Shareholders' Equity x 100
oReturn on Assets (ROA): Measures the efficiency of asset utilization in
generating profits.
Formula: Net Income / Total Assets x 100
2. Liquidity Ratios:
oCurrent Ratio: Measures a company's ability to meet short-term obligations.
Formula: Current Assets / Current Liabilities
