Importance Of Ratio Analysis

Submitted By kraken0414
Words: 395
Pages: 2

A ratio is an expression of the relationship of one item to another. A ratio can be expressed as a percent rate, or proportion. Ratios are particularly important in understanding financial statements because they permit us to compare information from one financial statement with information from another financial statement.

Financial ratio analysis uses formulas to gain insight into the company and its operations. For the balance sheet, using financial ratios can show you a better idea of the company's financial condition along with its operational efficiency. It is important to note that some ratios will need information from more than one financial statement, such as from the balance sheet, cash flow statement and the income statement.

• Current Ratio we consider the current ratio which reflects a company's ability to pay its short-term obligations. It is expressed as follows:
Current Ratio= Current Assets / Current Liabilities
A high current ratio suggests a strong liquidity position. However, an excessively high current ratio means that the company has invested too much in current assets compared to its current obligations. Since current assets normally generate a low return on investment, an excessive investment in current assets is not an efficient use of funds.
• Quick Ratio
Quick ratio focus on current asset composition. Quick assets include cash, short-term investments and receivables. These assets are the most liquid types of current assets. We compute the quick ratio as follows;
Quick Ratio=Cash+ Short-term Investments+ Receivables / Current Liabilities
• Accounts Receivable Turnover
It is desirable to collect receivables as promptly as possible. The cash collected from receivables improves solvency. In addition, the cash generated by