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Ratio Analysis

Ratio Analysis, an important tool for measuring financial health of the organizations. Ratio Analysis are concerned for investing firms into other organizations. Investing firms when want to invest in different firms / companies they want to know financial position of the firm / company. Investing Firms / Companies want to know, what is ability of firm to pay its outstanding, how firm meets  expenses, how efficiently use its assets and how much have a capability to pay their outstanding.
For finding their answers, following ratios help them to find our their answers.
Financial ratios are traditionally grouped into the following categories:
Short-term solvency, or liquidity, ratios
Ability to pay bills in the short-run
Long-term solvency, or financial leverage, ratios
Ability to meet long-term obligations
Asset management, or turnover, ratios
Intensity and efficiency of asset use
Profitability ratios
Ability to control expenses
Market value ratios
Going beyond financial statements



Short Term Solvency, or Liquidity Ratio 

These ratios relate to the firm’s ability to pay its bills over the short run without undue stress. So these ratios focus on current assets and current liabilities.Liquidity ratios are particularly interesting to short-term creditors.Financial managers are constantly working with banks and other short-term lenders, an understanding of these ratios is essential.
For calculating Solvency or Liquidity Ratio are includes:
Current Ratio: most common ratios to measure's the firm's ability to meet short term obligations Current Ratios =  Current Assets  / Current Liabilities 
Ratio of 2: 0 is acceptable by the creditors. High current ratio indicates  firms have high liquidity, but also indicates an inefficient use of cash and other short-term assets. Current Ratio more than 1 shows firms have positive networking capital and less than one shows firms have negative working capital. Creditors prefer higher current Ratios.
Quick (or Acid-Test) Ratio: The quick (acid-test) ratio is similar to the current ratio except that it excludes inventory, which is generally the least liquid current asset. The generally low liquidity
of inventory results from two primary factors: (1) many types of inventory cannot be easily sold because they are partially completed items, special-purpose items, and the like; and (2) inventory is typically sold on credit, which means that it becomes an account receivable before being converted into cash. The quick ratio is calculated as follows
 Quick (or Acid-Test) Ratio = Current Assets - Inventory / Current Liabilities
A quick ratio of 1.0 or greater is occasionally recommended, but as with the current ratio, what value is acceptable depends largely on the industry. The quick ratio provides a better measure of overall liquidity only when a firm’s inventory cannot be easily converted into cash. If inventory is liquid, the current ratio is a preferred measure of overall liquidity.
 


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