TYPES OF RATIO ANALYSIS

TYPES OF RATIO - TYPES OF RATIO ANALYSIS Careful financial statement analysis usually means the extraction of meaningful ratios from the statements

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TYPES OF RATIO ANALYSIS Careful financial statement analysis usually means the extraction of meaningful ratios from the statements. These ratios have been classified as measuring (1) liquidity (current ratio, acid-test ratio, etc.) (2) activity (receivables turnover, inventory turnover, etc.) (3) profitability (profit margin on sales, rate of return on assets, earnings per share, etc.) and (4) leverage (debt to total assets, times interest earned, etc.) [Kiesco and Weygandt,1982]. Ratios are often used to assess performance or as diagnostic tools to point up potential problem areas. Given the extremely varied entities for which financial statements are made -- and even the extreme variation between industries of an entity type -- the most productive use of these ratios is probably made either against industry standards or against ratios for previous years of the entity in question. CURRENT RATIO--THE PATRIARCH RATIO Current ratio (the ratio of current assets to current liabilities) was perhaps the earliest ratio to gain widespread use as a measure of solvency. On the theory that $2 in current assets could safely cover $1 of current liabilities (with enough remaining to operate) a 2-to-1 value became an inflexible standard. But inventories can vary greatly in their liquidities. Oil, for example, can be rapidly liquidated, but inventories of service parts could take years to sell -- hardly "current assets". Also, small businesses can often liquidate their inventories more rapidly than large ones,
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This note was uploaded on 01/12/2011 for the course ACCTING Acc423 taught by Professor Rob during the Spring '10 term at DeVry Long Beach.

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TYPES OF RATIO - TYPES OF RATIO ANALYSIS Careful financial statement analysis usually means the extraction of meaningful ratios from the statements

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