Classification of Ratios

Ratios Classification
Financial ratios can be classified according to certain aspects. There are 4 main classifications:

1. Profitability: The ratios indicate the relationship between profit & other key figures in the financial statements. Profit represents a primary measure for a business operation, & relates it with other key figures to get a clearer picture on the overall business performance.

2. Activities: Ratios related to activities measure the efficiency level of a company in using the assets. These ratios provide useful indications on a business's policy & operation efficiency.

3. Liquidity. Ratios classified in this category can be used to evaluate business capabilities to fulfill all short-term claims. It is extremely important for a business to hold sufficient liquid assets at all times. There are cases where a business shows profit but collapse because of insufficient liquidity. Weak liquidity may force a company to delay its payments & consequently companies listed as bad paymaster may lose the confidence of the lenders & creditors.

4. Leverage. It is essential in assessing financial risks in a company. Financial ratios in this leverage category are used to test the structure & financial capabilities of a company. The ratios are to identify relative contribution from the shareholders & lenders to finance the business. In addition, it tests business strength to repay long term debts.

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