Different types of ratios are used to analyze information from Profit and Loss Account (P&L Account) and Balance Sheet in order to compare business performance and judge the financial performance of a business organization.
Five different types of ratios
We are mainly focusing on limited liability companies in the private sector such as private limited companies (Ltd) and public limited companies (Plc).
1. PROFITABILITY RATIOS
The main business objective of all those firms is to make a profit. Profit is important for business survival and business growth. It also helps to determine how well a business is performing. Therefore, we will be looking at Profitability Ratios to see how spending on costs helps the business to generate revenue.
2. LIQUIDITY RATIOS
In addition, any business cannot depend only on profit to survive. It has to have enough cash available on daily basis, so it can pay any unexpected expenses to keep the business running. Therefore, we will also be looking at Liquidity Ratios to see how short-term liabilities are being managed.
3. EFFICIENCY RATIOS
Also, having knowledgeable and skillful managers is crucial to the success of any business both in the short-term and in the long-term. Therefore, we will be checking Efficiency Ratios in order to determine how well business managers do their job in terms of managing scarce resources such as capital, assets or inventories.
4. DEBT RATIOS
Further, having access to loan capital is necessary for the business to grow in the future. Therefore, Debt Ratios will help us examine the degree to which the business is relying on long-term debt to finance its operations. Or, if the business only uses its own capital instead.
5. INVESTOR RATIOS
Finally, having access to capital from investors is also important for a firm, especially for public limited companies during the global expansionary stage. Therefore, Investor Ratios will help current and potential investors assess the rate of return for their investments and the level of risk they are willing to take when buying shares.
In short, Ratio Analysis provides business stakeholders with important information to help them assess various aspects of a business organization. Different types of ratios will aid and improve decision-making as well as help to determine business attractiveness.
