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ACCOUNTING RATIOS:
1)SHORT-TERM SOLVENCY:
The current ratio is a test of a business’s short-term solvency — its capability to pay its liabilities that come due in the near future (up to one year). The ratio is a rough indicator of whether cash on hand plus the cash to be collected from accounts receivable and from selling inventory will be enough to pay off the liabilities that will come due in the next period. The different types of short term solvency ratio are –
- Current ratio: It addresses the current debt and asset of the company.
- Acid test ratio: This measures the ability of the company, how efficiently it uses its cash or asset.
- Inventory turnover ratio: It addresses how many times the inventory is used or sold in a year.
- Accounts receivable turnover: It indicates how efficient is a company in credit score and debt. Advantages of short term solvency ratio: Financial analysis: Short term solvency ratio is a good option, where you can understand the capability of the company in business. It uses only the current assets and liability pressure is less. Operating cycle: Short term solvency ratio enhances the operation cycle of the company. It quickly converts current assets into cash. It also helps with management efficiency.
Disadvantages of short term solvency ratio: Inventory : Short term solvency includes inventory in the calculation, which may lead to overestimation of the debt obligations and thus giving a wrong ratio result. Standalone failure: Short term solvency cannot withstand with huge liabilities and often proceed to ownership change.
2)LONG TERM SOLVENCY:
Long term solvency ratio is the total asset of the company divided by the total liabilities or debt obligations in the market. The different types of long term solvency ratio are –
- Debt Ratio: It measures the assets and debt obligation of a company.
- Equity ratio: It indicates the financial ratio of the company.
- Quick Ratio: A quick ratio is similar to acid test ratio but here the operation period is more.
- Cash Ratio: It is the ratio of income from assets and debt obligation. Advantages of long term solvency ratio: Quick cash : Long term solvency gives you the chance to quickly convert the assets into cash. This method can be applied if you want to profit in less time. Stock exchange: The business can be grown by sharing investments with shareholders and buying stock exchanges from the market. Net income can be reinvested with proper tax management. Disadvantages of long term solvency ratio:
Return on Equity A performance metric knows as return on equity (ROE) measures the revenues raised from shareholder equity. ROE is calculated by dividing net income by all outstanding stock shares in the market. Asset Turnover Ratio A metric called the asset turnover ratio measures the amount of revenue a company generates per dollar of assets. This figure, which is simply calculated by dividing a company's sales by its total assets, reveals how efficiently a company is using its assets to generate sales.
4)PROFITABILITY RATIO:
Profitability ratios are a class of financial metrics that are used to assess a business's ability to generate earnings relative to its revenue, operating costs, balance sheet assets, or shareholders' equity over time, using data from a specific point in time. Some examples of profitability ratios are- Profit Margin Different profit margins are used to measure a company's profitability at various cost levels, including gross margin, operating margin, pretax margin, and net profit margin. Gross margin measures how much a company makes after accounting for COGS. Operating margin is the percentage of sales left after covering COGS and operating expenses. The net profit margin is a company's ability to generate earnings after all expenses and taxes. Return on Assets
Profitability is assessed relative to costs and expenses and analyzed in comparison to assets to see how effective a company is deploying assets to generate sales and profits. The use of the term "return" in the ROA ratio customarily refers to net profit or net income—the value of earnings from sales after all costs, expenses, and taxes. ROA is net income divided by total assets. The more assets a company has amassed, the more sales and potential profits the company may generate. As economies of scale help lower costs and improve margins, returns may grow at a faster rate than assets, ultimately increasing ROA. Return on Equity ROE is a key ratio for shareholders, as it measures a company's ability to earn a return on its equity investments. ROE is net income divided by shareholders' equity. ROE may increase without additional equity investments, as the ratio can rise due to higher net income due to a larger asset base funded with debt.
CASH FLOW SATEMENT
The statement of cash flows, or the cash flow statement, is a financial statement that summarizes the amount of cash and cash equivalents entering and leaving a company. The cash flow statement (CFS) measures how well a company manages its cash position, meaning how well the company generates cash to pay its debt obligations and fund its operating expenses.
It is also righteous to say that a fund flow statement is prepared to explain the changes in the working capital position of a company. A fund flow statement comprises of : Sources of funds : It talks about the extent of funds availed from o Owners o Outsiders Application of funds : It talks about how the funds have been utilized o Funds deployed in Fixed assets o Funds deployed in Current assets
Preparation of Fund Flow Statement
Step 1: Preparation of Statement of Changes in Working Capital : Statement of Changes in working capital is a summary that shows the net increase or decrease in the working capital of the business. Step 2: Determination of Funds from Operations : Funds from operations refers to the profit earned or loss incurred from the regular business operation. Step 3: Preparation of Fund Flow Statement : After recognizing the funds/loss from operations, fund flow statement is prepared, which will show the net increase or decrease in the working capital.
