A Brief Discussion of the Most Used Ratio Analysis Techniques

A Brief Discussion of the Most Used Ratio Analysis Techniques
3 min read

Have you ever tried to analyze financial statements? If not, it would be pretty challenging to analyze cash flow at first glance. This article tells you some measures to make this procedure easier. 

Ratio analysis is a tool that can help us evaluate financial statements regarding a company's operating value and operational status. It includes comparisons for a coherent interpretation of financial statement ratio analysis, which is essential in the company planning process. It entails comparing the ratios to those of similar companies in the industry or examining the trends in the same company through time.  


The purpose of this article is to give you an introduction to the accounting ratio analysis and teach you about ratios, their significance, and how to compute them. 

Liquidity Ratios 

These ratios indicate whether or not the corporation can fulfill its short-term debt obligations/current liabilities and pay them off once they are due. They show if cash and cash equivalents are sufficient to cover short-term debt obligations. If the ratio value is larger than one, the firm's ratio analysis is liquid and in excellent financial health. But if it is less than one, it suggests that the company has failed to pay its responsibilities. 

Profitability Ratios 

Profitability ratios assess a company's operational competency, or how well it used its resources to make a profit, including its capacity to generate income and thus cash flow. The company's capacity to take debt and equity capital is directly influenced by cash flow. As a result, calculating this ratio is critical in determining how well a company's ratio analysis profitability is controlled. 

In many of these ratios, the larger the balance, the better for the corporation, indicating that the company is growing and generating income. To draw significant ratio analysis results, it is essential to undertake a comparison, i.e., perform trend analysis or industry analysis. 

Debt Ratios 

The debt ratio shows how much debt there is compared to the total number of assets. It represents the amount of debt the company has used to finance its purchases. The higher the ratio, the higher the risk associated with the company's operations. It has one more part called the debt-to-equity ratio. 

The debt-to-equity ratio shows how much of an entity's equity and debt is utilized to fund its assets. It assists in the evaluation of the company's health. Before granting any obligation, financial lenders desire a low debt-to-equity ratio. As a result, if this percentage is too high, more lending may not be available. This ratio's benchmark would be industry-specific, but the best value would be 1, i.e., when liabilities are equal to equity. 


Turnover Ratios 

It reflects the firm's efficiency in terms of asset management. It demonstrates how the company has made money by utilizing its assets. This ratio's criteria vary by industry and are determined by the number of purchases required. The relevant turnover ratios can be used to estimate asset utilization performance. 

Although the techniques seem a little confusing at first, you will understand them eventually. You can also hire accounts payable outsourcing services that will help you quickly understand the methods.  


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