Some common ratios used to analyze financial information profitability ratios, efficiency ratios, liquidity ratios, and solvency ratios.
Profitability ratios—are the gross, operating, and net profit margins. According to Kendra James on smallbusiness.chron, “Gross profit margin measures profitability after considering cost of goods sold, while operating profit margin measures profitability based on earnings before interest and tax expense. Net profit margin is often referred to as the bottom line and takes all expenses into account”(2012).
Efficiency ratios—measure how effective management is managing turnover rates and return on assets. Efficiency ratios also include inventory turnover, and sales to receivables. When measuring inventory turnover and sales to receivables a higher number proves better efficiency. Measuring return on assets involves comparing net income to total assets.
Liquidity ratios—are used to evaluate the company’s ability to settle current debts. Current ratios and quick ratios are the most common of liquidity ratios. Current ratio is found by dividing the current assets by current liabilities. The quick ratio determines what a company can pay on immediately.
Solvency ratios—or “leverage, ratios, judge the ability of a company to raise capital and pay its obligations”(James, 2012). This determines if a company can pay all of the debt it has. Debt to worth ratio is calculated by taking total liabilities divided by net worth.
The most important ratios are those needed in that certain circumstance. If the company is looking at the best way to increase profit the profitability ratios and solvency ratios may the most important. It all depends on the circumstance.
An example of how ratios are used in the decision making