Financial Analysis: The Forms of Financial Ratios

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The various forms of financial ratios that are calculated by businesses help to determine their financial strengths and weaknesses. The four major classifications of ratios are profitability ratios, leverage ratios, liquidity ratios and market valuation ratios. In this analysis, a systematic analysis of the ratios has been done and their values interpreted to help in making the sports shops decision.

Leverage Ratios To begin with, leverage ratios shows the extent to which the firm’s assets have been financed. These ratios show the extent to which the firm’s investments are financed and how the firm can meet its financial obligations as they fall due. They include: Interest Burden The ratio shows the proportion of earnings after interest expense to the operating profit before interest expense. The rates are 0.884, 0.937 and 0.968 from 2009 to 2011 respectively. There has been an improvement in the earnings of the firm after interest expense has been deducted to mean that the firm is reducing the interest charge on the Earnings before interest and tax. The company is almost eradicating all interest expense.

Interest Coverage (Times interest earned) The ratio shows the number of times in which the shops earnings before interest and tax can be used in repaying the shops interest charge. In the above scenario, the ratio is 8.627 in 209, 15.996 in 2010 and 31.119 in 2011. This shows that the company is in a position to pay its interest more easily as time increases. The company performance is on the increase.

Leverage The ratio shows the relationship between assets and equity. In this case, the proportion of assets financed from equity has been on the increase. In the year 2009 to 2011, the ratio moved from 1.896, 1.593, and 1.381 respectively. The figures are line with the reduction of interest rates since the firm’s assets has been financed by equity and not debt. The company’s debt is thus on the decline. Compound Advantage Factor The ratio gives the total leverage of the firm of both the financing extent and the earnings proportion after the external obligations have been discharged. In 2009, the ratio was 1.667, 1.4930 in 2010 and 1.337 in 2011 that implies that the external resources that is used by the firm in financing its activities together with the price paid for external finances is reducing desirably.

Asset Utilization Ratios The second set of ratios that we are going to analyze is the asset utilization ratios. The asset utilization ratios disclose the efficiency shops property has been use in generating the extra revenue. They are important in detecting whether the assets of the firm are used for the benefits of the organization or not. These ratios include Total Asset Turnover It shows the efficiency in which the shops property is used to generate cash. The higher the ratio the more efficient the resources are better utilized and the lower the ratio the poor the resources are utilized. In 2009, the ratio was 1.795, 1.913 in 2010, and 1.870 in 2011. This implies that there was an improvement in asset utilization in 2010 and a decline in 2011. The shop should thus improve n the level of asset utilization to ensure more profits.

Inventory Turnover This is another utilization ratio that measures how long inventory is kept in the warehouse before sales are made. The longer the period stock is kept in the warehouse the lesser the returns will be realized. If stock can be sold within the shortest duration, the shop would be in a position of making more sales hence better returns. For the shop the rate of turnover has improved from 3.125, 3.348 to 3.382 in 2009, 2010 and 2011 respectively. There are thus more sales with time.

Liquidity Ratios Liquidity ratios are ratio indicates the ability of a firm to meet its short-term financial obligation as they fall due. The ratios can be used to show firms that are likely to experience going concern problems and hence necessary actions taken. There are various kinds of these ratios.

Current Ratio The ratio will show the number of times that the current assets can be used to repay the current liabilities. A higher current ratio shows good performance for the firm. It could also mean that the shop has invested too much on current assets that reduce earnings. The ratio was 8.462 in 2009, 8.549 in 2010, and 9.014 in 2011 meaning that the shop has more current assets as compared to liability. The company can therefore not face liquidity problems.

Quick Ratio This ratio is sometimes referred to as the acid test ratio. It is a measure the number of times that the most liquid current assets excluding stock can be utilized in repaying the current liabilities. The inventory is normally deducted because it may sometimes take long before conversion into cash. There has been a significant increase in this ratio from 5.462 in 2009 to 6.014 in 2011 implying the firms increased ability to repay its current liabilities.

Cash Ratio This is a form of liquidity ratio that shows the extent to which the shop can meet the current liabilities from the most liquid assets which is cash and its equivalents. A higher cash ratio implies that the firm is more liquid than a lower ratio. From the statistics, the cash ratio was 5.462 in 2009, 50549 in 2010, and 6.014 in 2011 indicating the increased shop liquidity.

Profitability Ratios Profitability ratios indicate the ability of a firm to generate income from its investments or asset. Every business with a need to earn profit will work towards high profitability ratio. Profitability ratios are either calculated as a percentage of assets or sales level. Profitability ratios that include: Return on Assets The ratio shows the operating income before interest and tax as a percentage of assets. It reflects on how well assets have earned the firm income. There has been a stable increase in this ratio of 0.184 in 2009, 0.242 in 2010, and 0.276 in 2011 showing the increases shop return on assets. The reduced interest cost, high liquidity are the factors to be attributed to these good performance.

Return on Equity This is profitability ratio which indicates the net profit t as a proportion of equity. It shows how well owner’s finances have earned profit. This ratio has realized a good performance from 2009 to 2011 i.e. 0.206, 0.266 and 0.270 respectively. The owner of the shop has realized increased return on his investment.

Return on Sales (Profit Margin) This profitability ratio is calculated with respect to sales and not assets. It indicates the relationship of sales and returns. For the shop the ratio shows good performance from 0.102 in 2009 to 0.126 in 2010 and 0.148 in 2010 which imply a better performance with time In conclusion the small business sports shop has performed significantly well and is likely to realize better performance as indicated by the ratios. The fact that the shops assets are best utilized has resulted in profit improvement and debt reduction, which has further increased the liquidity of the firm. Ratios are important indicators of business performance.

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