Understanding Concepts - Essay Example

Balance Sheet Ratio Analysis calculates solvency and liquidity of a business. They include Current Ratios = Total Current Assets / Total Current Liabilities. The ratio shows whether a business has sufficient current assets to meet its current debts and leave a margin of safety in case of current assets losses such as collectable accounts or inventory shrinkage. Two to 1 is the favourable current ratio (Stickney, 2010). If the current ratio of a business is low, turning fixed assets into current assets, debts payment, and taking back profits into the business can help raise it.

Quick Ratios / acid-test ratio = Cash + Government Securities + Receivables / Total Current Liabilities. 1:1 is the satisfactory acid-test ratio. Working Capital is calculated by taking Total Current Assets less Total Current Liabilities. Leverage Ratio or Debt/Worth Ratio = Total Liabilities / Net Worth. It indicates how far a business relies on debt financing. If this ratio is high, it becomes hard to obtain credit. Income Statement Ratio Analysis measures profitability. They include Gross Margin Ratio = Gross Profit / Net Sales.

It calculates the sales dollars left inform of a percentage to cover the company’s overhead expenses. Net Profit Margin Ratio = Net Profit before Tax/ Net Sales. It details the sales percentage, which remain after deducting the Cost of Goods sold and any other expenses apart from income taxes (Stickney, 2010). Management Ratios include Inventory Turnover Ratio = Net Sales / Average Inventory at Cost indicates how effectively inventory is managed. Accounts Receivable Turnover Ratio (in days) = Accounts Receivable / Daily Credit Sales; it shows how effectively the receivables are collected.

Return on Assets Ratio = Net Profit before Tax / Total Assets; it measures how effectively profits are being derived from the assets in the