Discuss the various categories of financial ratios used in financial statement analysis.docx

Discuss the various categories of financial ratios used in financial statement analysis. Provide at
least two examples of each type of ratio and discuss what the particular ratio tells us about the
performance of a company.
Answer:
i. Liquidity Ratio:
Liquidity ratios are an essential financial calculation that are used to estimate or calculate the
debtor’s ability to repay its short term outstanding financial obligations (paid off within the fiscal
year) without having the need to raise any external capital. The two main calculations in the
liquidity ratio includes current rationed quick ratio.
- Current Ratio:
The quick ratio indicates/ calculates if the organization is able to pay off its shorter debts. It
addresses how the company can maximizes the current assents in the balance sheet to satisfy
the current debts and payables. It is calculated by:
Current Ratio = Current Asset / Current Liability
If the current ratio is less than 1, then, we can conclude that the company has more payables
than the available capital and receivable and thus won’t be able to pay off its financial
obligations in due time. However, if the current ratio is more than 1, then, it indicates that the
company has the ability to pay off its obligations. However, it may also indicate that the
company unsold inventory or is unable to take utilize its assets effectively.
- Quick Ratio:
The quick ratio indicates/ calculates if the organization is able to pay off its shorter debts
with its liquid assets (current assets that can be quickly turned into cash with little impact on
the price received in the market). It measures the dollar amount asset available in that year
against the dollar amount of the liabilities of the organization. It is calculated by:
Quick Ratio = (Current Asset – Inventories - Prepaid Expenses) / Current Liabilities
If the quick ratio is 1, then it is called a normal ratio. It just shows that the company is
capable to liquidate its assets to pay off for the liabilities. However, if the company has liquid
ratio less than 1, then the company may not be able to pay off its liabilities in the short term,
while the comet having quick ratio more than 1 can easily pay off for its liabilities.