Financial accounting covers a large portion that deals with ratio analysis and without compact ratio analysis examples it is tough to understand what to do or, really how to do. In this section it will direct the readers about the usage of ratios and their formulas.
Here the approach is based purely on the ratios solely. It doesn’t aim at anything different than their merit. The approach of financial statements is not followed here.
#Working capital ratio:
Every entity has a supply of short term funds to meet its short term demands. It is not a question of having enough funds, but, a matter of having enough funds in time. Having a complete balance of current liabilities and current assets is not a very good situation for any entity. It’s healthy to keep more than what needed and thus the concept of working capital (Mostly positive) which gives a perfect condition for entities to go further and invest in newer projects.
Calculation of working capital goes like this:
(-) Current liabilities
This is the base that is needed to calculate the ratio. The formula for the ratio is:
#Quick ratio or, Acid test ratio:
Some debt demands prompt repayment and that occurs within a very short span of time. Knowing this, concerned parties can easily learn how well the company is managed to meet all its requirements for paying the debts that come with a short term notice.
The formula here is:
Only a few items of current assets is taken into consideration here. It’s because these items are the only ones which can generate money on a very short notice.
As the last one among the liquidity ratios it gives a complete look into the assets section of any entity’s balance sheet that provides the base for paying out liabilities that need to be paid within one financial year. The ideal condition of this ratio is 2:1.
The formula here is:
Liquidity ratio is meant to provide the idea about paying out the short term debt and its funding. But, it is not complete and ratios from activity section helps in subsequent calculations.
#Net profit margin:
The income generated from sales generally shows the picture of the overall profit. The net profit margin is the return on sales as that gives the funding to meet the cost occurred to make the product and also the expenditures afterwards.
#Return on assets:
Asset is the funding employed by the entity to get profits as much as possible. So getting to know the return on assets is the motto to learn the profit generated from the investments.
#Return on investment:
Here the investment is considered in a reversal manner. The investment is the one that generates cash even if that created liability in return.
The formula is: