Financial ratios:

Financial ratios are important indicators of the performance of a company, these ratios are used to predict outcomes and also in decision making. Some of the examples of these ratios include current liquidity ratio, working capital turnover ratio, and current debt to net worth ratio, inventory turnover ratio and cash flow to debt ratio.

This paper will discuss the following financial ratios:

 – Current liquidity ratio – Working capital turnover ratio – Current debt to net worth ratio – Inventory turnover ratio – Cash flow to debt ratio

– Current liquidity ratio

The current liquidity ratio is calculated by dividing current assets with current liabilities

Current assets/ current liabilities = current liquidity ratio

This ratio helps to uncover weaknesses in the companies financial system, this ratio are used by suppliers, short term creditors and banks to determine the credit worth ness of a company, it helps to uncover the weaknesses of a business.

Working capital turnover ratio

Financial Ratios

The working capital turnover ratio is calculated by dividing the net sales with working capital

Net capital/ net working capital = working turnover ratio

This ratio also helps in providing information regarding the financial position of a company or business, this ratio helps determine the company requires additional fund in terms of investment, if this ratio is low then there is need to reinvest more funds and if the ratio is high then managers require not to invest more.

– Current debt to net worth ratio

This ratio is calculated by dividing current liabilities with tangible net working capital

Current liabilities/ tangible net working capital = Current debt to net worth ratio

This financial ratio gives us the proportion of funds that all current creditors contribute to the operation of the company. If this ratio for a small firm is 60% a then something must be done, for a large company the limit is 75% and this means that there should a change in finances to solve the problem.

– Inventory turnover ratio

The inventory turnover ratio is calculated by dividing the cost of goods sold with average inventory.

Financial Ratios

Cost of goods sold/average inventory = inventory turnover ratio

If this ratio is equal or more than 100% then the inventory level is not too high but if it is less than 100% then there is need to increase inventory. This ratio helps to determine the level of inventory a company should hold.

–      Cash      flow to debt ratio

The cash flow to debt ratio is calculated by dividing cash flow with total debts, the cash flow is calculated by adding net income to depreciation.

Cash flow/ total debt = Cash flow to debt ratio

Cash flow = net income + depreciation

This ratio helps to determine the level of debtors a company should maintain, if the ratio is too low then this means that company may in the long run provide for bad debts

All the above ratios are important in reporting the financial position of a company or business, they are calculated to aid in the forecasting and at the same time decision making.

Financial Ratios

Financial Ratios

## References:

Eric P. (2002) Analyzing Financial Statements, Lebahar Friedman publishers, New York

Leopold Bernstein (2000) Analysis of Financial Statements, McGraw-Hill publishers, New York

Peter A. and E. McLaney (1997) Accounting and Finance for Non-Specialists Prentice Hall publishers, US

Daniel Jensen (1997) Advanced Accounting, McGraw-Hill Publishing, New York

Martin Mellman (1994) Accounting for Effective Decision Making, Irwin Press, UK