Ratio analysis is used to evaluate relationships among financial statement items. The ratios are used to identify trends over time for one company or to compare two or more companies at one point in time. Financial statement ratio analysis focuses on three key aspects of a business: liquidity, profitability, and solvency.

Liquidity Ratios

Liquidity ratios measure the ability of a company to repay its short‐term debts and meet unexpected cash needs.

Current ratio

The current ratio is also called the working capital ratio, as working capital is the difference between current assets and current liabilities. This ratio measures the ability of a company to pay its current obligations using current assets.

Current Ratio = Current Assets / Current Liability

Quick ratio

Current Ratio = Quick Assets / Current Liability

Inventory turnover

The inventory turnover ratio measures the number of times the company sells its inventory during the period. It is calculated by dividing the cost of goods sold by average inventory. Average inventory is calculated by adding beginning inventory and ending inventory and dividing by 2.

Inventory Turnover ratio = Cost of Goods Sold / Average inventory

Debtors Turnover (Receivables turnover)

The debtors turnover ratio calculates the number of times in an operating cycle (normally one year) the company collects its receivable balance. Net credit sales are net sales less cash sales. If cash sales are unknown, use net sales. Average net receivables are usually the balance of net receivables at the beginning of the year plus the balance of net receivables at the end of the year divided by two.

Debtors Turnover = Credit Sales / Average Net Receivable

Debtors turnover Days (Average collection period)

The average collection period (also known as day's sales outstanding) is a variation of receivables turnover. It calculates the number of days it will take to collect the average receivables balance. It