Types of Ratio Analysis

The process of analyzing ratios will totally depend upon the types of ratio analysis used for comparisons. You must wisely choose the ratio types so that it helps you in the future.

It also depends upon the type of business. Inventors, managers, employees use the operating performance ratio, risk ratio, growth ratio, and solvency ratio analysis.

This section will deal with all the different types of ratio analysis.

Furthermore, the list will also include a number of other sub ratio analysis types, such as types of financial ratios which will also be dealt with here.

Solvency Ratio Analysis

Solvency Ratio Analysis in accounting is divided into two types of ratios that are turnover ratio and liquidity ratio.

Turnover Ratio

This ratio uses the receivables turnover ratio, days receivables, inventory turnover ratio, and days inventory. It also uses account payable turnover, days payable, and cash conversion cycle.

This determines the number of sales done by the company when compared to the accounts received.

Liquidity Ratio

It involves the current ratio, quick ratio, and cash ratio. This is helpful in determining the ability of the company to cover its expenses.

It is especially useful in telling you how easily you can convert the assets of your company into cash (i.e., liquidity). This ratio is usually compared with the liabilities of the company. Hence, balance sheet items calculate this ratio.

Operating Performance Ratio Analysis

The operating performance ratio analysis comprises the operating efficiency ratio and profitability ratio. This can determine the overall performance of the company based on its assets and its returns.

Operating Efficiency Ratio

This will include asset turnover ratio, net fixed asset turnover, and equity turnover ratio. This will follow a deep comparison between the total assets of your company along with the sales.

Profitability Ratio

It combines the gross profit margin, operating profit margin, net profit margin, return on total assets, return on total equity, return on owner’s equity, and DuPont ROE. This is calculated based on the total cost, sales, and profit. This is helpful in maintaining the expenses of the company.

Risk Ratio Analysis

Risks in a business can happen at any time due to various uncertainties. For risk analysis, a company looks into three types of risks. They are business risks, financial risks, and external liquidity risks.

This will include operating leverage, financial leverage, and total leverage. Risks can happen anywhere in the financial statement. Hence, only a proper ratio analysis interpretation can prevent the company from facing losses.

Financial Risks

Financial Risks usually happen with the company taking loans from banks or partners. To prevent defaults from happening in these cases, the leverage ratio, the DSCR ratio, and the interest coverage ratios are used.

External Liquidity Risks

These risks include the trading volume and bid-ask spread. You should analyze these factors so that your company understands the stock prices in a better way. Using the trade volume, you can also decide about the liquidity of the stocks of your company.

Growth Ratio Analysis

The growth rate is the major criterion to tell about your company’s development. When the company grows bigger, the growth rate should become more sustainable. Similarly, this factor will encourage your investors too. So this analysis includes sustainable growth analysis.

Sustainable Growth Analysis

To analyze sustainable growth factors like the rate of return on equity and the retention of earnings should be taken into account. This will help the investors to know about their future earnings as they invest. It also supports the valuation of your business.

Financial Leverage Ratios

Financial leverage ratio or debt ratio is equity or a measurable factor. Basically, the hierarchy of a company is quite risky regarding capital. It can also be said that financial leverage ratios sum up the debt the company has to pay to correspond to the shares or assets. Differences in this financial leverage ratio generate two types of situations-

When the stockholder owns the major share then the organization holds the tag of less leveraged.
If the shares held by the creditors are in majority then the organization holds the tag of more leverage.
Too many of the debts are troublesome for the company as it will raise questions about its financial operations. Financial leverage ratios are of two types –

Debt Ratio

It is a ratio that quantifies the extent of the assets of any company. It can also be estimated as the generalized ratio of assets to liabilities.

Through the debt ratios, the investors and stockholders can easily analyze the entire amount which they have to pay and also the extent of the company to pay the debt in the future. The debt ratio also throws light upon the fact that how many assets can be sold to meet the liabilities.

Equity Ratio

is a financial quantity that depicts the relatability between the company assets and finance required for it. The sum of liabilities and stockholders’ possession gives the exact value of assets.

Under the situation where a company earns higher on the assets rather than paying the debts, then a less equity ratio can be considered fruitful.

Market Prospect Ratios

Market prospect ratios are helpful for the evaluation of public sectors/ companies considering the deflation and inflammation with the stock prices. The stockholders and experts use this ratio so that they can make an estimate of the stock price and can easily figure out the value of assets.

Usually, investors make a huge bet upon this ratio as it is not an open fist.

Working Capital Ratio

In order to overcome or avoid bankruptcy for the organization, the working capital ratio can be very useful. It quantifies the potential of the company to increase its turnover and grow. Two of the most affecting factors in the working capital ratio are-

If the ratio of assets to liabilities is below 1 then the company has less working capital ratio.
If the company has the highest working capital then it is also considered a negative thing.

Conclusion

This tells us about the importance of ratio analysis that makes a company or your business strong. It drafts a clear evaluation of what to focus on, in the present and how to improve these metrics for the future.

Ratio analysis is helpful in learning about your own company from every perspective. It is the clubbing of ratios that helps you make good decisions, as it reduces any biases owing to the use of only a single ratio.

Any single metric cannot be sufficient to decode your financial statements. Hence, this is the most reliable method to carry out the financial analysis.

Now that you have been introduced to the basics of ratio analysis, you may have some queries to clarify. We can help you with them in the comment section. We will be pleased to hear your comments and to clear your doubts.