Financial statements (balance sheets and profit & loss account) show how much profit a business has made and how it is using the money invested. However by looking at financial statements alone it is difficult to fully assess how a business is growing and whether it is financially secure. Financial Ratios will help you to work out how well a business is doing based on its;
Volume of Sales
Profit
Size
Borrowings
Dividends
Stock and
The type of money invested in the business.
This diagram illustrates financial ratio categories
Ratio Categories
Financial Ratios are divided into five categories
Profitability Ratios
Liquidity Ratios
Gearing Ratios
Activity Ratios
Shareholder Ratios
Profitability Ratios
As the name suggests Profitability Ratios look at profit. Profitability ratios examine the relationship between gross profit, net profit and the money invested in the business. Read our article about Profitability Ratios to learn more.
Liquidity Ratios
In the financial world liquidity means cash, therefore Liquidity Ratios focus on current assets as they can easily be turned into cash. They also cover current liabilities as these may reduce the amount of liquidity that the business has. Current liabilities are short term debt that needs to be paid off in less than a year. Read our article about Liquidity Ratios to learn more.
Gearing Ratios
Gearing ratios focus on the long term debt that the business has. Long term debt is debt that the business as more than a year to pay back. Gearing ratios are said to examine a business’ long term financial standing. Read our article about Gearing ratios to learn more.
Activity Ratios
A business’ key activity is to sell stock and receive the money that it is owed from the sale. As a result activity ratios concentrate on how much money the stock generates, how quickly stock is sold and how long it takes to receive money from debtors. Read our article about activity ratios to learn more.
