Financial Ratios: Ratio Types Analysis

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Introduction

The financial ratios are very important to investors and nursing facilities can be able to make comparison of its company’s performance in relation to other firms. Most of the ratios are usually calculated from the information that is given by a company. These ratios can be used to assess trend and make comparison of financial firms. In some cases ratio assessments can be used for future prediction. This paper will explore several ratios to explain how these ratios are useful

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Liquidity Ratios

These ratios are a set of financial metrics that business managers use in determining the firm’s ability to make payment of its short-term debts responsibilities. generally higher ratios are a show of larger margin and this is a safe for a company as it implies it can take care of its short oeriod debts. A health care’s facility ability to convert short-term assets into liquid money to meet the debts is of utmost significance when creditors are looking for payment (Finkler & Ward, 2006, p. 67).

Current Ratio

Current ratio is used in evaluation of the company or a medical facility in nursing in this paper to cover its short-term debts (Finkler & Ward, 2006, p. 67). The formula is given by

Current ratio = Current/Current liability

A very high current ratio is an indication of a company that will face difficult to borrow on s short notice. A generally accepted value of current ratio is 2:1 and the minimum ratio is 1:1.

Acid Test Ratio

This ratio is a measure of the immediate amount of cash that can be readily available to cover for the short term debts. Acid Test ration formula is given by

(Cash + Marketable securities)/Current Liabilities.

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Common Size Ratios

These are ratios used by managers to make comparisons of financial statements of varied size firms. The same ratios could be used for the same company comparison but at different development periods (Bull, 2008, p. 63; Finkler & Ward, 2006, p. 67).

Common Size ration: The following is a formula is given by

Common size Ratio = Commodity of Interest/Reference Commodity.

For instance, if the commodity of interest is inventory and it’s referenced to the sum of assessment quality. The ratio will be

Common Size Ratio for Inventory = Inventory/Total assets

The ratios are in most case expressed as percentages of the reference quantity (Bull, 2008, p. 63). These ratios are made for balance sheet and income statements.

Efficiency Ratio

The efficiency ratios are used for measuring the worth of a business’ receivables and how effectively it makes use and manages its assets, how efficiently the company pays suppliers, and whether the firm is over-trading or under-trading on its equity (Bull, 2008, p. 63).

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Breakeven Point

This is a point of operation in which a business in neither making profits or loses. The formula is given by

Breakeven Point = fixed/contribution margin

The breakeven explain the minimal amount of sales that are needed for a company to make profits. When the breakeven point increases, it’s an indication of increase risk of loss (Bull, 2008, p. 63).

Accounts Receivable Turnover Ratio

This ratio represents the number of times the accounts receivable are taken in a year (Eastaugh, 1998, p. 46). The formula for this is given by

Accounts Receivable Turnover Ratio = Annual Credit sales/Average Accounts Receivable.

A high ratio shows a very tight credit policy while a low ratio is an indication of problem in collecting the receivable turnover and this could be because of bad debt.

Solvency

Solvency ratio is a measure of financial reliability of a business, or the business risk which is the ability of the company to pay its debts devoid of cash flows (Eastaugh, 1998, p. 46). This is a measure of how effective a company satisfies its short and long term responsibilities.

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Quick Ratio

This is at times referred to as acid test and works with only cash, securities that can be sold faster and the accounts receivable since they are regarded as liquid type of assets. A 1.0 or less quick is an indication of a company’s dependence on inventory and other current assets that can be liquidated. This way one can determine ability to meet the short-term debts (Finkler & Ward, 2006, p. 67). This ratio is calculated by

(Cash + Accounts Receivable)/Current Liabilities

Current Ratio

This ratio makes a comparison of current assets against current liabilities. This is in most cases used as a means of measuring the short-run solvency (Cleverly & Cameron, 2007, p. 52). That is the immediate ability of a company to meet the current debts as soon as they are due. Potential creditors usually use these ratios to weigh up a firm’s liquidity or ability to meet up the short period debts. The formula is

Current assets/current liabilities

Profitability

Profitability ratio indicate a firms overall effectiveness and performance. The profitability ratios are in two categories, i.e. margins and returns. The ratios that show profit margins show the company’s ability to convert the sales into the profits at several stages of evaluation (Finkler & Ward, 2006, p. 71). The returns ratios demonstrate a company’s capacity to evaluate its efficiency in creating returns for the investors.

Gross Profit Margin

This is a ratio for assessing the cost of goods as a percentage of sales. This ratio is used to determine how well a firm is able to manage the cost of its inventory. The ratio also considers a company’s cost manufacturing and consequently how the cost is passed to the clients (Cleverly & Cameron, 2007, p. 54). Large margin indicates the company is doing well. The formula for this is

GPM = Gross profit/net sales

Return on Investment

This ratio is critical as it assesses the efficiency of a company in managing its investment and using them for profit making (Cleverly & Cameron, 2007, p. 54). This is a gauge of the profits a firm earns relative to investment with regard to the total assets. It is calculated by

RoI = Net Income/Total Assets

Reference List

Bull, R. (2008). Financial Ratios: How to Use Financial Ratios to Maximize Value and Success for Your Business, Amsterdam, Boston Elsevier Science & Technology.

Cleverly, W. O., & Cameron, A. E. (2007). Essentials Of Health Care Finance (6th Ed.). Sudbury, MA: Jones and Bartlett.

Eastaugh, S. (1998). Health Care Finance: Cost, Productivity & Strategic Design, Sudbury, MA: Jones And Bartlett.

Finkler, S. A., & Ward, D. M. (2006). Accounting Fundamentals for Health Care Management. Sudbury, MA: Jones and Bartlett.

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