What Are the Five Major Categories of Ratios?
The five categories of financial ratios are liquidity (solvency), leverage (debt), asset efficiency (turnover), profitability and market ratios. These ratios measure the return earned on a company’s capital and the profit and expense margins on each of its sales.
Liquidity or solvency ratios are described as the ability for a company to settle its debts by liquidating its assets. The basic idea of this ratio is to understand the company’s value of its assets in relation to its debt or long-term obligations to other financial institutions. This ratio measures the company’s availability of cash after liquidation.
Leverage ratios are the company’s ability to pay off its long-term debt to financial institutions or financial partners. While similar to liquidity ratios when it comes to settling debt, this ratio measures the company’s current financial standing, net payments pending, liquidity and interest coverage.
Efficiency or activity ratios measure the company’s use of resources. This ratio takes in the total amount of sales, collection times and sales. Activity ratios are a way to measure a company’s current financial standing as a running business.
Profitability ratios measure the company’s current rate of return. This takes into account the company’s current net sales versus gross profit as well as net sales versus operating income. With a profitability ratio, owners can see the company’s future stability by measuring how well it’s keeping itself above water based on its overall income and running costs.
Market ratios take a look at the business outside the company with its shareholders, relationships with shareholders and its market activity. This measures the amount of direct profit and sales versus company costs and its ability to protect its financial relationship with outside shareholders while establishing a fair market price that will rise and fall with the company’s progress.