Types of Ratios
There are four types of ratios:
1. liquidity ratio
2. debt ratio
3. activity ratio
4. profitability ratio
1. LIQUIDITY RATIO
Liquidity refers to the ability of a concern to meet its current obligations as &
when they become due. The short-term obligations of a firm can be met only
when there are sufficient liquid assets. The short-term obligations are met by
realizing amounts from current, floating or circulating assets.
The current assets should either be liquid or near liquidity. They should be
convertible into cash for paying obligations of short-term nature. The sufficiency
of current assets should be assessed by comparing them with short-term
liabilities. If current assets can pay off current liabilities, then liquidity position
will be satisfactory.
To measure the liquidity of a firm the following ratios can be calculated:
(i) current ratio
(ii) quick ratio
(a) current ratio: it may be defined as the relationship between current
assets and current liabilities. The ratio also known as working capital
ratio is a measure of general liquidity and is most widely used to make
the analysis of a short-term financial position (liquidity) of the firm.
!"##$%& !""#$"
Current ratio = !"##$%& !"#$"!"%"&'
Current Assets Current Liabilities
Cash in hand Outstanding expenses
Cash at bank Bank overdraft
Bills receivable Bills payable
Inventories Short-term advances
Work-in-progress Sundry creditors
Marketable securities Dividend payable
Short-term investments Income-tax payable
Sundry debtors
Prepaid expenses
!"##$%& !""#$" !""#$
Current ratio = !"##$%& !"#$"!"%"&' = !"!#$ = 0.59
(b) quick ratio:
Quick ratio is a test of liquidity than the current ratio. The term liquidity
refers to the ability of a firm to pay its short-term obligations as & when
they become due. Quick ratio may be defined as the relationship between
quick or liquid assets and current liabilities. An asset is said to be liquid if
it is converted into cash within a short period without loss of value.
!"#$% !" !"#$"% !""#$"
Quick ratio = !"##$%& !"#$"!"%"&'
Current Assets Current Liabilities
Cash in hand Outstanding expenses
Cash at bank Bank overdraft
Bills receivable Bills payable
Sundry debtors Short-term advances
Prepaid expenses Sundry creditors
Marketable securities Dividend payable
Short-term investments Income-tax payable
!"#$% !" !"#$"% !""#$" !!"##
Quick ratio = !"##$%& !"#$"!"%"&'
= !"!#$ = 0.42
(2) Solvency Ratio
Solvency of a business means the business is in a position to meets its
long-term financial obligations as and when they become due.
Solvency ratios are the ratios, which show whether the enterprise will be
able to meet its long-term financial obligations, i.e., long-term obligations.
(a) Debt Equity Ratio (D/E Ratio)
It shows the relationship between long-term external debts and
shareholders funds.
!"#!!!"#$ !"#$
D/E Ratio = !"#$%"&'(%$! !"#$
!"#$%
à D/E Ratio = !"#$$ = 1.036
(b) Total Assets to Debt Ratio
• This ratio measures the safety margin available to lenders of long-
term debts.
• It measures the extent to which debt is being covered by assets.
!"!#$ !""#$"
Total assets to debt ratio = !"!!!"##$%& !"#$"!"%&
!"#"$
à Total assets to debt ratio = !"#$% = 3.29
(c) Proprietary Ratio:
Proprietary ratio establishes the relationship between proprietors’ funds
and the total assets.
!"#$%"&'(%$ !"#$%
Proprietary Ratio = !"#$% !""#$"
Ø This ratio shows the extent to which total assets have been financed by
the proprietor.
Ø The higher the ratio, the higher the safety for lenders and creditors.
