What is Ratio Analysis?

The study of numerous financial records in a business's financial statements is known as ratio analysis. Ratio analysis are used mainly by outside analysts to figure out things like a company's liquidity, profitability, and solvency. Analysts use current and historical financial statements to analyze a company's financial performance. They use the data to see if a company's financial condition is improving or deteriorating, and to make a comparison to other companies.

There are six categories of financial ratios in ratio analysis

Liquidity Ratios

Liquidity ratios evaluate a company's capacity to repay short-term loans and meet unpredictable financial requirements.

Coverage Ratios

Coverage ratios are used to assess a company's capacity to meet its debt and other commitments. Analysts use the coverage ratios to create a pattern that anticipates the company's financial status in the future over numerous reporting periods. A higher coverage ratio indicates that a company can more easily fulfil its debts and associated responsibilities.

Leverage Ratios

Leverage ratios measure how reliant a company is on debt to fund its operations. The majority of leverage ratios compare assets and liabilities. A high leverage ratio increases a company's risk and exposure to business crises, but it also increases the possibility for larger profits.

Efficiency Ratios

Efficiency ratios assess how successfully the company utilizes its assets and obligations to create profit and sales. It helps to calculate the use of inventories, machinery, liability turnover and equity use. These are significant because the company may generate more sales and profits if the efficiency ratios are improved.

Profitability Ratios

Profitability ratios measure the ability of the company to generate profit compared to its related expenditure. A greater profits ratio demonstrates that the firm is improving financially than the prior financial reporting year. The profitability ratio also determines how lucrative the business is compared to its competing companies.

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