Classification of financial ratios on the basis of functionality:
In relation to the premise of capacity testing or assessment, many financial ratios are used to be calculated. The primitive ratios, the proportions are categorized under the following heads that is the liquidity ratios followed by the profitability ratios and the activity efficiency ratios and lastly but certainly not the least are the Solvency ratios.
Financial Ratios and the Stakeholders
The aforementioned categories of the financial relations (ratios) target different stakeholders and their information needs. There may be several stakes and therefore there is variety in relation to the information needed as far as stakes are concerned. For instance, liquidity ratios usually demonstrate the stake that is in relation to the current accounting period. Liquidity ratios demonstrate the stake of such liabilities that are for surely going to be due in the coming 12 months from the reporting date.
The providers of the debt for the very organization in generally and the long-term debt are particularly concerned about the solvency state of the company. Quite similar to the liquidity, the solvency is the assessment to pay what would be due in the long-term that is in the coming two years and beyond that term.
The preceding instances highlight and emphasize the importance of the financial ratios and how they are used by different stakeholders in relation to the assessment of their respective stakes and concerns.
Financial Ratios and the Auditors
Auditors are very much concerned with the financial ratios. Financial ratios assist the auditors in the finding of the soundness of the company that is whether the operations are conducted with effectivity and efficiency. Auditors are responsible for sharing the opinion about the execution of the operations of the entity and this is why efficiency ratios concern the auditors much.
Financial Ratios Computation
It is not necessary that you keep on rotting every formula of the specific financial ratio. What is indeed important that you understand the concept and the formula will follow for surely. For instance, when I know that current ratio is a liquidity ratio and it is usually employed to have knowledge if the specific company has to dispose of its short-term liabilities, it would be automatically clicked to your mind that this ratio will involve current assets and liabilities. The word ratio suggests that it would be a fraction and would have numerator and denominator.
This is why financial ratios understanding is very important. The questions related to the financial ratios in the examination hall requires little interpretation skills as well which is only possible when you have the full understanding of the specific ratio.
When financial ratios are computed over the years for instance in relation to two consecutive years, required interpretation increases a little. In this case, you would not only set out what this ratio mean but would also set out whether it increases or decreased over the time and what financial implications do this increase or decrease in term of that specific computed ratio hold in relation to the company.
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