Once the financial statements are made, they are ready to get analyzed. One such tool to analyze the financial statement is ratio analysis. It allows you to better understand the current scenario financially. Let us take a detail about the Ratio Analysis:
Meaning of Ratio Analysis
Before understanding the meaning of ratio analysis, first, you should know what is ratio. In finance, the ratio is the comparison of two accounts. Ratio analysis is the process of examining the financial information by calculating the financial statement percentage instead of comparing items form each financial statement.
Ratio analysis hence becomes a vital tool for financial management and financial analysis.
Different Types of Ratios Used in Analysis Are-
1.Liquidity Ratio: This is also known as solvency ratio. It focuses on the company’s assets and liabilities and ensures that the company is liable to pay the short term debt or not. The three common liquidity ratios used in financial analysis are the current ratio, quick ratio, and absolute liquid ratio.
2.Profitability Ratio: This ratio shows how a company is good at making profits by analyzing how the assets are used and how they are helping to generate profits. The common ratios in this are gross profit ratio, net profit ratio, and operating profit ratio.
3.Capital Structure Ratio: Each company has the capital to finance the operations, this ratio analyzes how the company uses the capital effectively. Some of the ratios are capital structure ratio or debt-equity ratio.
4.Working Capital Ratio: This ratio is crucial for the creditors to establish the liquidity of the company. It also analyzes that the company can pay off the debts and liabilities using the current debts or not. The common working capital ratios are inventory ratio, debtors turnover ratio, creditors turnover ratio.
5.Overall Profitability Ratio: True to its name, it analyzes how profitable a company is or how it can turn its assets for profits in the future. An overall profitability ratio is used to calculate the profit of the company.
These are the different types of ratios which can be used to analyze the financial statements using ratio analysis. Despite knowing the fact that some of these ratios are easy to calculate, it is somewhat difficult to memorize these ratios. Having a working knowledge of these ratios can speed up your financial analysis.
Here are some tips to remember the ratio analysis formulas to analyze financial statements quickly-
Tip 1: Categorize the Ratios.
To keep in mind the formulas of the ratio, categorization works well. Categorizing each set of financial ratios on the basis of the information they provide will help you keep all the formulas of different ratios direct in your mind. This is the best way to memorize the formulas.
Tip 2: Writing Down Each Ratio and Start Working on them.
When you simply memorize the ratios, it is difficult to remember each of them. Instead, you can write down the ratio and work on each ratio with different numbers until you remember the formula. By doing this, you will be able to remember the formulas easily.
Example: current ratio= current assets / current liabilities
Current assets=640, current liabilities= 540
So, the current ratio=640/540
After solving this, you can take another example to solve the current ratio until you remember the formula.
Tip 3: Understanding.
One of the difficulties in memorizing the financial ratios is the lack of understanding. Understanding each ratio will enhance the mind’s ability to retain the information. When you know about a topic and understand it, it becomes easier to remember the topic rather than memorizing the topic. Understanding the problem or situation is an important part of any field.
Tip 4: Use Pictures.
Visual representation of each element of the ratio helps you remember the ratios easily. It is hard to memorize the formulas with complex numbers or equations. The concept behind this is that your mind’s tendency to remember pictures is better rather than words or symbols. An example of this would be imaging a debt as a giant pillar of money on the head of the owner. Whenever you see debt in the ratio, the scene will come in the mind along with some other elements.
Connecting each element through a story help you better understand the topic.
These are some tips suggested by our finance assignment help experts to memorize the ratio analysis formulas quickly. They will be helpful when you perform the financial analysis using the ratios of the ratio analysis.