Annual reports contain financial ratios that help users understand the financial performance and position of a company. Financial ratios simplify complex financial data and make comparison easy. They help investors, creditors, management, and analysts evaluate liquidity, profitability, efficiency, and solvency of a business. Ratios are calculated using figures from financial statements such as balance sheet and profit and loss account. These ratios support decision making, performance analysis, and trend study. In India, important financial ratios are disclosed in annual reports as per regulatory requirements to improve transparency and accountability.
1. Current Ratio
Current ratio measures the short term liquidity position of a company. It shows the ability of a business to meet its current liabilities using current assets. This ratio is important for creditors and suppliers. A higher current ratio indicates better liquidity, while a very low ratio shows working capital problems. However, an excessively high ratio may indicate idle resources. This ratio helps in assessing short term financial stability of the company.
Formula
Current Ratio = Current Assets / Current Liabilities
2. Quick Ratio
Quick ratio is also known as acid test ratio. It measures the immediate liquidity position of a company. Inventory is excluded because it cannot be quickly converted into cash. This ratio provides a more conservative view of liquidity. Creditors prefer this ratio to judge immediate payment capacity. A higher quick ratio shows strong short term solvency. It is useful when inventory takes long time to sell.
Formula
Quick Ratio = Quick Assets / Current Liabilities
3. Gross Profit Ratio
Gross profit ratio indicates the relationship between gross profit and sales. It reflects efficiency in production and pricing policy. A high gross profit ratio shows good control over cost of goods sold. A declining ratio may indicate rising costs or reduced selling prices. Management uses this ratio to evaluate operational performance. Investors use it to compare profitability among similar companies.
Formula
Gross Profit Ratio = Gross Profit / Net Sales × 100
4. Net Profit Ratio
Net profit ratio shows overall profitability after deducting all expenses. It measures the percentage of profit earned on sales. A higher net profit ratio indicates better management efficiency and cost control. A lower ratio may be due to high operating or non operating expenses. This ratio is useful for judging earning capacity and financial performance of a company.
Formula
Net Profit Ratio = Net Profit / Net Sales × 100
5. Return on Capital Employed
Return on capital employed shows how efficiently capital is used to generate profits. It considers both equity and borrowed funds. A higher ratio indicates effective utilization of resources. This ratio is useful for long term performance evaluation. Investors and analysts use it to compare companies with different capital structures.
Formula
ROCE = Operating Profit / Capital Employed × 100
6. Debt Equity Ratio
Debt equity ratio measures the relationship between borrowed funds and owners’ funds. It indicates long term solvency and financial risk. A high ratio shows greater dependence on debt, increasing financial risk. A low ratio indicates financial stability. Creditors and investors use this ratio to assess capital structure.
Formula
Debt Equity Ratio = Total Debt / Shareholders’ Equity
7. Inventory Turnover Ratio
Inventory turnover ratio measures efficiency of inventory management. It shows how many times inventory is sold during a period. A high ratio indicates efficient stock management and fast movement of goods. A low ratio shows slow moving or excess stock. This ratio helps management control inventory costs.
Formula
Inventory Turnover Ratio = Cost of Goods Sold / Average Inventory