The 5 Types of Financial Ratios

​The next financial ratio category included in our list of financial ratios is the efficiency ratio. Two of the most common solvency ratios you can use are the debt-to-equity ratio, and the times interest earned ratio. In the list of financial ratios above, as you can see that there are five major categories of financial ratios. These ratios are commonly used by investors, and we’ll take a closer look Law Firm Accounting and Bookkeeping 101 at each of them, in turn, below. Accounting ratios cover a wide array of ratios that are used by accountants and act as different indicators that measure profitability, liquidity, and potential financial distress in a company’s financials. The ratios are used by accountants and financial professionals to communicate and investigate problems or successes within a designated time period.

This ratio measures profitability gained by a company using its assets and liabilities. It measures a company’s profitability against its book value, this is the biggest limitation of this ratio too. It weighs shareholders’ equity with the total liabilities of the company. It shows the value of the total liabilities of a company compared to the amount of money invested by shareholders. The administration of an organization can likewise utilize financial ratio analysis to decide the level of effectiveness in the administration of assets and liabilities. One of the purposes of financial ratio analysis is to compare an organization’s financial performance with comparable firms in the sector to grasp the organization’s situation on the lookout.

What Is an Example of Ratio Analysis?

Key market value ratios include dividend yield, earning per share (EPS), the price-to-earnings ratio, and the dividend payout ratio. Efficiency ratios include the asset turnover ratio, inventory turnover, payables turnover, working capital turnover, fixed resource turnover, and receivables turnover ratio. The quick ratio is another way of helping you pinpoint a company’s financial strength. It’s also known as the “acid test.” As the name suggests, it’s a more stringent measure of its ability to meet its obligations.

Benchmarks are also frequently implemented by external parties such lenders. Lending institutions often set requirements for financial health as part of covenants in loan documents. Covenants form part of the loan’s terms and conditions and companies must maintain certain metrics or the loan may be recalled.

The Five Types of Financial Ratios

Third, ratio analysis can be performed to strive for specific internally-set or externally-set benchmarks. To correctly implement ratio analysis to compare different companies, consider only analyzing similar companies within the same industry. In addition, be mindful how different capital structures and company sizes may impact a company’s ability to be efficient. In addition, consider how companies with varying product lines (i.e. some technology companies may offer products as well as services, two different product lines with varying impacts to ratio analysis). Likewise, they measure a company today against its historical numbers. In most cases, it is also important to understand the variables driving ratios as management has the flexibility to, at times, alter its strategy to make it’s stock and company ratios more attractive.

These comprise the firm’s “accounting statements” or financial statements. The statements’ data is based on the accounting method and accounting standards used by the organisation. A financial ratio or accounting ratio is a relative magnitude of two selected numerical values taken from an enterprise’s financial statements. Often used in accounting, there are many standard ratios used to try to evaluate the overall financial condition of a corporation or other organization. Financial ratios may be used by managers within a firm, by current and potential shareholders (owners) of a firm, and by a firm’s creditors.

List of Efficiency Ratios: Formula & Analysis

Normally, these ratios are calculated and assess the analyst’s concern or want to know about the financial situation of the entity like when the loan is in consideration to be provided to the entity. These ratios are popular for analysts working in the bank as well as investment companies. Another https://business-accounting.net/the-starting-salary-for-accounting-firm-lawyers/ thing that we need to consider when interpreting these ratios is the conflict between numbers of ratio with liability turnover or payable turnover ratio. The analyst uses these groups of ratios to assess how well an entity could generate profits from using certain resources as well as expenses.

• This ratio should be used in combination with the Average Performance of actual payments and the payment history of the customer to assess how long they might take to pay the outstanding balance.
• If you’re a finance professional tasked with reporting, you’re probably using financial ratios in some capacity already–and it’s exactly because they are so widely used that they’re so useful.
• They can rate and compare one company against another that you might be considering investing in.
• This will enable you to chart a course towards a more financially sustainable future for your company.
• Consider the inventory turnover ratio that measures how quickly a company converts inventory to a sale.
• Receivables turnover shows how quickly net sales are turned into cash.