Ratio Analysis - Definition, What is Ratio Analysis, Advantages of Ratio Analysis, and Latest News - ClearTax (2024)

Introduction

Ratio analysis is a quantitative procedure of obtaining a look into a firm’s functional efficiency, liquidity, revenues, and profitability by analysing its financial records and statements. Ratio analysis is a very important factor that will help in doing an analysis of the fundamentals of equity.

Analysts and investors make use of the methods for ratio analysis to study and evaluate the fiscal wellbeing of businesses by closely examining the historical performance and monetary statements.

Comparative data and analysis can give an insight into the performance of the business over a given period of time by comparing it with the industry standards. At the same time, it also measures how well a business racks up against other businesses functioning in the same sector.

Liquidity Ratios

These ratios evaluate a business’ efficiency to settle its debts as and when they become due, with its revenues or assets in the disposal. Liquidity ratios cover quick ratio, current ratio, and the working capital ratio.

Solvency Ratio

Solvency ratios are also referred to as the financial leverage ratios. These ratios will compare an organisation’s level of debt with assets, earnings, and equity in order to determine the possibility of an organisation to stay in operation over an extended period of time by settling all its short and long-term debts and by paying coupon/interest regularly. Solvency ratios include interest coverage ratios, debt-asset ratios, and debt-equity ratios.

Profitability ratios

Profitability ratios indicate how efficiently a business will be able to generate revenues and profits through its operations. Profit margins, return on equity, return on assets, gross margin ratios, and return on capital employed are good examples of profitability ratios.

Efficiency ratios

Efficiency ratios are also called as the activity ratios. These ratios determine the efficiency of a business by using its liabilities and assets to boost sales and optimise profits. Inventory turnover and turnover ratios are examples of efficiency ratios.