The financial statement analysis ratios enable us to validate a company’s performance. These are simply ratios based on data from financial statements that assess if a company is a profitable, can pay off its debts and is utilizing money wisely. You can also consider liquidity ratios, profitability ratios and solvency ratios for financial statement analysis ratios. These are true snapshots of the company’s state. AR = No of days taken to collect receivable amount from customer as per an year (360 days) _ To all the students of India preparing accounts or ACCA or CA exam this ratios will definitely help you in understanding financial performance metrics easily.
Importance of Financial Statement Ratios
They use ratios based on the information in the financial statements to tell us how strong or weak a business is. They aid accountants to make good decisions, investors, banks, and even business owners. These ratios show a company’s profit margins, loan and debt payment ability, and asset management. In their absence, we can’t compare two companies or assess a company’s growth over a period.
Why Ratios are Needed?
You open a company’s financial statement and it’s just a laundry list of numbers? Only focusing on numbers is not the solution. You need to examine the numbers to see if the company is in good shape or headed for trouble. And this is exactly where ratio analysis in accounting comes in handy.
Financial reporting sorted — on Ratios. Just look at a ratio and we know the state of a company. If a company has a low current ratio, we know it may not be able to pay all its short-term bills, for example. High return on equity means good profits for the owners of the company.
True use of ratios in decisions
- Ratios also help an investor to know which companies to invest.
- For lenders: Whether a company can pay me back. Ratios tell banks.
- For managers: Ratios help prepare for better utilization of company cash.
- For students Ratios are part of accounting studies and exams.
These ratios hold an important place in Indian business examinations such as CA and ACCA. Anyways, on the lighter note, a little part you must know that these metrics determine how well you actually score and to be a prospective accountant you need some wisdom. This ratio transforms complex numbers into simple answers.
Types Of Financial Ratios For Analysis
Different types of ratios for financial statement analysis Liquidity, profitability and solvency ratios are the major ones. However, each of these ratios highlights varying dimensions of a companies fiscal health.
Liquidity Ratios
Liquidity ratios show if a company can meet its short-term liabilities. The debts have to be serve in a also small time, thus enterprise must process enough money or asset. Liquidity ratios assess the whether a company can meet both current and short-term obligations. Put your skills to the test with our current ratio formula & quick ratio example.
Current Ratio
The current ratio formula is:
Current Ratio = Current Assets / Current Liabilities
This ratio must be greater than 1 That is, its assets are greater than its liabilities. A ratio less than 1 may indicate that the company will have difficulty paying their bills. }
- Example: For example, a company has ₹2,00,000 of current assets and ₹1,00,000 of current liabilities:
Current Ratio = 2,00,000/1,00,000 = 2
That puts the company in pretty good shape.
Quick Ratio
The quick ratio is otherwise referred to as the acid test ratio. It removes the inventory out of the current-assets, since inventory might take some time to sell. What will the liquidity zero be in a month?
Quick Ratio = Current Assets – Inventories / Current Liabilities
This already-short metric is a better indicator for short-term struggles.
- Example:For instance : If a company has current assets of ₹1,50,000, inventory of ₹50,000, and current liabilities of ₹1,00,000:
Quick Ratio = (1,50,000 − 50,000) / 1,00,000 = 1
That means the company can meet that obligation even without selling products.
Cash Ratio
Its quotient is the closest test of liquidity. It just works on the cash and cash equivalents (like bank balance) on the basis of which it checks if the company is able to pay its current liability.
Cash Ratio = Cash + Cash Equivalents / Current Liabilities
A number of 1 or greater means the company can pay all its short-term debts with just its cash.
A very low ratio might indicate that the company is overly reliant on receivables or inventory to settle its liabilities.
- Example:A company has Cash and Cash Equivalents worth ₹60,000 and Current Liabilities of ₹1,00,000. What is the Cash Ratio?
Cash Ratio = 60,000/1,00,000 = 0.6
That’s cash used to fulfill 60% of short term consolee) accounts.
Profitability Ratios
These ratios are discussed in the context of how efficiently the company earns profits. They show how much money the company retains after paying everyone’s bills. Profitability ratios show the profit earned by the business firms.
Return on Equity
Return on equity or ROE is how much the company returns profit to the company owners.
ROE = Net profit / [Equity] Shareholder’s equity
A high ROE means the company is performing well.
- Example: For example if we have a net profit of ₹1,00,000 and equity of ₹5,00,000,
ROE = customer net profit after tax = 1,00,000 / 5,00,000 = 0.2 (20%)
Indicate for each ₹1 expenditure, company earns 20 paise profit.
Net Profit Margin
This ratio reflects how much profit a firm puts in its pocket per sales.
Net Profit Margin = (Net Profit / Revenue) ×100
A higher number is better.
Gross Profit Margin
This ratio indicates how much money of the total sales the company manages to maintain if we exclude COGS.
Gross Profit Margin = (Revenue – Costs of Goods Sold) / Revenue × 100
A correction on what is a very critical in entities engaging on trading and manufacturing. The lower one indicates that the company is controlling its overhead.
- Example: In this example, Revenues = ₹5,00,000, COGS = ₹3,00,000
Gross Profit Margin = (5,00,000 – 3,00,000)/5,00,000 * 100 = 40%
Each ₹1 sale returns 40 paise to the company net of goods.
Operating Profit Margin
It shows the income that the company is making from everyday operations before paying interest and taxes.
Operating Profit Margin = Operating Profit/Revenue ×100
And so no return on investment or non-business activity can be applied.
- Example: Operating profit = ₹120,000, revenue = ₹600,000
Operating Margin = Operating profit / Sales = 1,20,000 / 6,00,000 × 100 = 20%
Solvency Ratios
Solvency ratios give you an idea of long-term safety. We have already seen that ratio of debt to equity. Let’s explore some more now. These ratios are calculated to check whether the long-term loans can be recovered in solvency.
Debt to Equity Ratio
This is a pot to differentiate borrowed money vs owners money.
Debt to Equity Ratio=Total Debt/ Shareholder’s Equity
If it is low, the company belongs to a lot of debts that you rely on too much.
- Example: Let us assume a company is having ₹3,00,000 of debt and ₹1,00,000 of equity
Debt to Equity Ratio = 12lacs / 4lacs = 3
This is high and risky.
Interest Coverage Ratio
This tells whether a company is making enough income to pay the interest on its debt.
V = Interest Coverage Ratio = EBIT / Interest Expense
What Does EBIT Mean? → EBIT Definition: Earnings Before Interest and Taxes
- Example: EBIT = 2,00,000; Interest = 40,000
So, Interest Coverage = 2,00,000/40,000 = 5
So the company collects 5x their interest payment. That is a good sign.
Debt Ratio
This indicates the degree of debt financing of total assets.
Debt Ratio = Total Liabilities ÷ Total Assets
If this ratio is high, it indicates that a majority of the assets are funded through debt.
- Example: Net Worth = Total Assets – Total Liabilities = 1000000 – 400000 = Rs.
Also read: Debt: 4,00,000/Earnings: 10,00,000 = 0.4 or 40%.
Safe date 0.5 greater than risky date 2120.
Efficiency Ratios
Activity ratios (or efficiency ratios) They show how well a company gets its resources like stock and money from customers.
Inventory Turnover Ratio
It calculates how many times inventory is sold and replaced in the course of a year.
Inventory Turnover = COGS / Avg Inventory
Time on the market: Average number of days in uniform, higher means inventory moves quickly and that is a good thing.
- Example:: COGS = ₹8,00,000, Avg. Inventory = ₹2,00,000
Inventory Turnover is calculated by dividing sale of inventory by average value of inventory Inventory Turnover = Sale of Inventory/(Opening Inventory + Closing Inventory) / 2 Inventory Turnover = 8,00,000 / 2,00,000 = 4
Meaning they’re selling stock quarterly instead of bi-annually.
Receivables Turnover Ratio
This is how quick a company gets paid by its customers.
Here is the formula we can use: Receivables Turnover= Net Credit Sales Average Receivables
- Example:Net Credit Sales₹10,00,000, Avg. Receivables = ₹2,00,000
Receivables Turnover = 10,00,000 / 2,00,000 = 5
This denotes that the firm charges the fee 5 times each year
| Category | Ratio Name | Formula | What it Shows? |
| Liquidity | Current Ratio | Current Assets / Current Liabilities | Ability to pay short-term debts |
| Quick Ratio | (Current Assets – Inventory) / Current Liabilities | Ability to pay short-term debts quickly | |
| Cash Ratio | Cash / Current Liabilities | Pure cash position | |
| Profitability | Gross Profit Margin | (Sales – COGS) / Sales × 100 | Profit from goods sold |
| Operating Profit Margin | Operating Profit / Sales × 100 | Profit from operations | |
| Return on Equity | Net Profit / Shareholder’s Equity | Returns to shareholders | |
| Solvency | Debt to Equity Ratio | Total Debt / Equity | Debt risk level |
| Interest Coverage Ratio | EBIT / Interest Expense | Ability to pay interest | |
| Debt Ratio | Total Liabilities / Total Assets | How much assets funded by loans | |
| Efficiency (Bonus) | Inventory Turnover Ratio | COGS / Average Inventory | How quickly inventory is sold |
| Receivables Turnover Ratio | Credit Sales / Average Receivables | How quickly customers pay |
Relevance to ACCA Syllabus
Financial statement analysis is on every ACCA qualification, but it is particularly well represented in both the Financial Reporting (FR) and Strategic Business Reporting (SBR) ACCA papers. Financial health is assessed using profitability liquidity efficiency and solvency ratios. These tools are indispensable to analysts in accounting and finance, evaluating business performance and risk. Against this backdrop, ACCA learners apply these ratios to case studies, group accounts and real-world business analysis.
Financial Statement Analysis Ratios ACCA Queations
Q1: What is the measurement of the current ratio?
A) Profit per dollar of sales
B) Current ratio (current assets/current liabilities)] — ability to pay off short term debts with current assets
C) Total Equity Return
D) Inventory turnover in days
Ans: B) Cashed It is called a current ratio and liquidity ratio because it is similar word to cash.
Q2: The company has a quick ratio of 0.8 in the balance sheet. What does this indicate?
Corporate is greatly, greatly, greatly profitable.
B) Firm [is] keeping too much inventory
D) The company is likely unable to pay its current and future debts
D) A company has a strong solvency position
Ans: C) Company might be having difficulty to pay short-term liablities
Q3: How is Return on Capital employed(ROCE) calculated?
A) Net Income / Total Assets
B) Operating Profit / Capital Employed
C) Gross Profit / Revenue
D) Net Profit / Signers’ Equity
Ans: B) capital employed = Operating Profit / Capital employed
Q4: “How does the ratio applied to monitor a host’s assets’ productivity generate a sale?”
A) Debt-Equity Ratio
B) Inventory Turnover Ratio
C) Gross Profit Margin
D) Current Ratio
Acc: B) Inventory Turnover Ratio
Q5: Which ratio best indicates a company’s long-term ability to cover obligations?
A) Quick Ratio
B) Return on Equity
C) Debt to Equity Ratio
D) Operating Margin
Ans: C) Debt to Equity Ratio
Relevance to US CMA Syllabus
Here will try to relate the analysis of financial statement ratios with the US CMA syllabus.
The following section is “Financial Statement Analysis” in the US CMA exam. Candidates learn to use the common-size analysis and ratio analysis and trend analysis in evaluating a company’s performance. CMAs help in ratio analysis to bring decision making and forecasting and advising management in maintaining operational efficiency.
Financial Statements Ratios Analysis CMA Questions
Q1: What is the profit of a company with interest and tax expenses?
A) Return on Assets
B) Net Profit Margin
C) Operating Margin
D) Gross Profit Margin
Ans: B) Net Profit Margin
Q2 : What is gross profit ratio, animate? What does this show?
A) the execution of fixed asset liquidity
B) COGS (% revenues) as revenues were flat
C) Return on capital employed
D) Interest earned on savings
Ans: B) COGS (% revenues) as revenues were flat
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Q3: Smaller ratio would least be affected by depreciation Answer:
A) ROA
B) Fixed Asset Turnover
C) EBITDA Margin
D) Net Profit Margin
Ans: C) EBITDA Margin
Q4: High Inventory turnover ratio means:
A) Over-purchasing of stock
B) High inventory turnover
C) Weak sales performance
D) Slow-moving inventory
Ans : B) Better control on inventory
Q5: How do you analyze the cost structure of the business, and what ratio do you apply?
A) Net Profit Margin
B) Debt to Asset Ratio
C) Operating Margin
D) Acid Test Ratio
Ans: C) Operating Margin
Relevance to US CPA Syllabus
The significance of Ratio Analysis can be gauged from its relevance in the Financial Accounting and Reporting (FAR) & Business Environment and Concepts (BEC) section of this exam. Ratios are fundamental factors for CPA to present financial resources, risk and profit (financial ratios of liquidity and solvency, capital ratio of capital structure).
Financial Statements Ratios Analysis CPA Questions
Q1: Which key financial metric which tells us how many dollars of profit a firm generates for each dollar of equity capital?
A) Return on Assets
B) Return on Equity
C) Gross Profit Margin
D) Current Ratio
Ans: B) Return on Equity
Q2: For how long the receivables are to be collected?
A) Inventory Days
B) Receivables Turnover
C) Days Sales Outstanding
D) Asset Turnover
Ans: C)Days sales outstanding — (DSO)
Q3:Comparative Sustainable Finance Affordability (SFA) — only solvency ratio is used.
A) Quick Ratio
B) Current Ratio
C) Debt to Equity Ratio
D) Gross Margin
Ans: C) Debt to Equity Ratio
Q4: What is net profit after taking away what is assets in terms of revenue to sales?
A) Gross Profit Margin
B) Net Profit Margin
C) ROCE
D) Inventory Turnover
Ans: A) Gross Profit Margin
Q5:If a company has high current ratio and low quick ratios, then the working capital for the company is:
A) Reserves=Strong Liquidity
B) Excessive receivables
C) High inventory levels
D) No current liabilities
Ans: C) High inventory levels
Relevance to CFA Syllabus
CFA Level 1 syllabus has a section “Financial Reporting and Analysis” Ratios is an important concept under this section as Ratios are one of the important concepts of how financial statements are read. As such, ratio can be a universal valuation tool, risk assessment tool, and comparability tool, and therefore, ratio analysis is one of the topics that makes the list in all levels of CFA. They serve as the foundation for analyzing equity, managing a portfolio, and analyzing credit.
Financial Statements Ratios Analysis CFA Questions
Q1: What is your formula to calculate returns on total assets employed into the business?
A) ROCE
B) ROE
C) ROA
D) Gross Margin
Ans: C) ROA
Q2: Which of the following is NOT a operational efficiency measures?
A) Operating Margin
B) Current Ratio
C) Earnings Per Share
D) Debt Coverage Ratio
Ans: A) Operating Margin
Q3: Decrease in ICR is an indication of:
A) Rising asset productivity
B) Higher interest burden
C) Lower taxes
D) Better liquidity
Ans : ( B ) Interes burden increases
Q4: Which ratio will be mainly used to assess a firm financial leverage?
A) Gross Profit Margin
B) Total Asset Turnover
C) Debt to Equity Ratio
D) Current Ratio
Ans: C) Debt to Equity Ratio
Q5: Which of the following is a limitation of the Cash Ratio as a liquidity metric?
A) It includes all current assets, including inventory
B) It excludes receivables and inventory, which may be liquid in some cases
C) It accounts for non-cash operating expenses
D) It is the most comprehensive metric for long-term solvencyAns: B) It excludes receivables and inventory, which may be liquid in some cases
