Financing and Marketing Management

Unit 6 - Basic Accounting Procedures or Analysis of Business Performance

6.5. Ratio analysis
Meaning: ratio analysis is the technique of the calculation of a number of accounting ratios from the data or figures found in the financial statements, the comparison of the accounting ratios with those of the previous years or with those of other concerns engaged in similar line of activities or with those of other suitable ratios, and the interpretation of the comparison. In other words, ratio analysis is “the technique of interpretation of financial statements with the help of the accounting ratios derived from the financial statements”.
Types or classification of ratios:
Accountants and financial managers have developed a wide variety of ratios over a period of time. But there is no standard classification available in the accounting literature. Various accounting ratios can be broadly classified into a) Traditional classification or classification accounting to their nature. b)Functional classification or classification according to tests or classification on the basis of specific purpose.

Traditional classification:
According to this classification the ratios are classified into: i) Balance sheet ratios ii) Income statement ratios iii) Combined or mixed or inter statement ratios.

Functional classification:
According to this classification the ratios are classified into: (i) Liquidity ratios (or stability test ratios) (ii) Long term solvency ratios (or stability test ratios) (iii) activity ratios (or performance test ratios) ( iv)Profitability ratios (v) Earning ratios.

• Liquidity Ratio of Ratio Analysis, facilitates to identify whether the company has enough capability to meet short term obligations/requirements. Current and Quick Ratios reveal the comparison between CurrentAssets and Current Liabilities suggest for necessary decision making.
• The Profitability Ratios like Gross Profit Ratio, Net Profit Ratio and Operating Ratio give a picture of profitability position of the concern.
• Long term solvency and the leverage ratios such as Debt-Equity Ratio and Interest Coverage Ratio convey a firms ability to meet the interest cost repayments schedules of its long-term obligations and show the proportions of debt and equity in financing of the firms.
• Activity Ratios such as Inventory Turn Over Ratio, Debtor Turnover Ratio, Working Capital Turnover Ratio measure the efficiency with which the resources of a firm have been employed.