Ratio analysis is the process of determining and interpreting numerical relationship between figures of the financial statements.

 

Financial Ratios

Financial ratios, which use data from a firm's balance sheet, income statement, statement of cash flows, (and certain market data for cross-verification), are often used when evaluating the financial performance of the firm.

 

Liquidity ratios indicate a firm's ability to meet its short-term financial obligations.

 

• Asset management ratios indicate how efficiently a firm is using its assets to generate sales.

 

• Financial leverage ratios indicate a firm's capacity to meet short and long-term debt obligations.

 

• Profitability ratios measure how effectively a firm's management generates profits.

Liquidity Ratios

These involve the following:

Current Ratio: This ratio is used to assess the short-term financial position of the business concern.However, many Current Assets e.g. rent paid in advance, cannot be readily encashed, whereas Current Liabilities must be paid when they fall due. Therefore, another ratio, called the Quick Ratio, is more representative in portraying the liquidity situation.

Quick Ratio: Liquidity ratio/ ‘acid test' ratio is worked out to realistically portray the short-term liquidity position of the firm.

 

Quick ratio =	Current Assets-Inventory-Prepaid Expenses
	Current liabilities