Types of Financial Ratios: Liquidity, Profitability, Efficiency, Leverage & Market Ratios

What Is a Financial Ratio?

A financial ratio shows the relationship between two figures in a company’s financial statements. For example, a profit after tax of ₹90 lakh has limited meaning on its own. If revenue is ₹1,200 lakh, the net profit margin is 7.5%. This percentage can be compared with earlier years or similar businesses.

A ratio highlights an area that may require attention. The underlying accounts, business conditions and accounting policies explain why the result changed.

5 Types of Financial Ratios

Financial ratios can be grouped according to what they measure. This guide covers five common categories: 

Financial ratios use figures from the balance sheet, profit and loss account, sales records and other financial reports. Apply the same formula and definitions across periods to keep comparisons meaningful.

Notes:

• Current assets and liabilities: Current assets are normally realised or used, and current liabilities settled, within the operating cycle or 12 months.
• Revenue from operations: Income from the business’s main activities, such as sales of goods or services.
• Quick assets: Current assets minus inventory, prepaid expenses, advance tax and other amounts that cannot be converted into cash quickly.
• Average balance: The opening balance plus the closing balance, divided by 2.
• Capital employed: Total assets minus current liabilities, or shareholders’ equity plus long-term debt. Use the same method consistently.
• Use figures reconciled with the financial statements and supporting ledgers.

Which Financial Ratio Should You Check First?

How to Calculate Financial Ratios

Use this four-step checklist:

1. Select the reporting period and collect reconciled figures from that same period.
2. Check classifications, particularly current versus non-current balances and interest-bearing debt versus trade payables.
3. Apply the formula stated in this guide and document any definition used.
4. Calculate ratios consistently, compare them with earlier periods or suitable peers, and investigate material changes in the underlying accounts.

The figures given below are illustrative. Each example uses a separate data set and demonstrates a calculation method rather than an industry benchmark.

Liquidity Ratios

Liquidity ratios assess whether a business has sufficient short-term resources to meet obligations due soon.

Current Ratio

A current ratio above 1 means recorded current assets exceed recorded current liabilities. It does not prove that sufficient cash will be available when payments become due.

Inventory may take time to sell, receivables may be overdue and some cash may be restricted. The result should therefore be read in light of the timing and quality of the underlying balances.

Example: If a business has current assets of ₹450 lakh and current liabilities of ₹250 lakh, its current ratio is:

₹450 lakh ÷ ₹250 lakh = 1.80

Quick Ratio

The quick ratio provides a stricter view of short-term liquidity by excluding inventory and other less-liquid current assets.

A business with regular cash sales may operate safely with a lower quick ratio than one that depends on slow customer collections. An apparently strong result may still require attention if receivables are old, disputed or doubtful.

Example: If current assets are ₹450 lakh, including ₹200 lakh of inventory and ₹20 lakh of prepaid expenses and advance tax, quick assets are ₹230 lakh. With current liabilities of ₹250 lakh:

₹230 lakh ÷ ₹250 lakh = 0.92

Profitability Ratios

Profitability ratios assess earnings in relation to revenue, assets and capital.

Gross Profit Margin and Net Profit Margin

Gross profit margin shows how much revenue remains after direct costs. Net profit margin shows how much remains after operating expenses, finance costs and tax.

Reading both margins together helps explain why profit changed. If gross margin stays the same but net margin falls, check whether business expenses, depreciation, interest, tax or one-time costs have increased, or whether other income has fallen.

Example: If revenue is ₹1,200 lakh, gross profit is ₹360 lakh and profit after tax is ₹90 lakh:

• Gross profit margin = ₹360 lakh ÷ ₹1,200 lakh × 100 = 30%
• Net profit margin = ₹90 lakh ÷ ₹1,200 lakh × 100 = 7.5%

Return on Assets

ROA helps assess how much profit is generated relative to the asset base. It is most useful when compared with earlier periods or businesses with a similar operating model.

Example: If profit after tax is ₹90 lakh and average total assets are ₹915 lakh:

₹90 lakh ÷ ₹915 lakh × 100 = 9.8% ROA

Return on Equity

ROE measures the return earned on shareholders' funds. A high result may come from strong profit, a small equity base or increased borrowing. It should therefore be considered alongside debt and interest obligations.

Example: If profit after tax is ₹90 lakh, opening shareholders’ equity is ₹540 lakh and closing shareholders’ equity is ₹660 lakh, average equity is ₹600 lakh:

ROE = ₹90 lakh ÷ ₹600 lakh × 100 = 15% 

Return on Capital Employed

ROCE assesses operating profit against the long-term funds used in the business. Because it uses profit before interest and tax, it can help compare businesses with different financing structures.

Example: If profit before interest and tax is ₹150 lakh and capital employed is ₹750 lakh:

ROCE = ₹150 lakh ÷ ₹750 lakh × 100 = 20% 

Efficiency Ratios

Efficiency ratios assess how effectively assets, inventory and customer balances support revenue.

Asset Turnover

Asset turnover can help identify how much revenue is generated relative to the assets used by the business. However, results can differ significantly between industries and business models.

Example: If revenue from operations is ₹1,200 lakh and average total assets are ₹915 lakh:

Asset turnover = ₹1,200 lakh ÷ ₹915 lakh = 1.31 times 

Inventory Turnover and Inventory Days

Inventory turnover indicates how often average inventory is sold or used during the period.

Example: If cost of goods sold is ₹840 lakh and average inventory is ₹190 lakh:

₹840 lakh ÷ ₹190 lakh = 4.42 times

For a one-year period:

365 ÷ 4.42 = about 83 inventory days

Inventory days should be compared with product shelf life, supplier lead times and customer demand.

Trade Receivables Turnover and Collection Days

Trade receivables turnover shows how quickly customer balances are collected. Dividing 365 by the turnover ratio gives estimated collection days.

Example: If net credit sales are ₹1,200 lakh and average trade receivables are ₹200 lakh:

Trade receivables turnover = ₹1,200 lakh ÷ ₹200 lakh = 6 times

Collection days = 365 ÷ 6 = approximately 61 days

If the business offers 30-day credit terms, the result indicates that collections are taking approximately 31 days longer than the stated terms. 

Leverage Ratios

Leverage ratios assess the use of borrowed funds and the ability to meet finance costs.

Debt-to-Equity Ratio

The debt-to-equity ratio compares interest-bearing debt with shareholders' equity. It shows how much the business relies on borrowed funds relative to owners' funds.

Example: If interest-bearing debt is ₹300 lakh and shareholders' equity is ₹400 lakh:

₹300 lakh ÷ ₹400 lakh = 0.75

This means the business has ₹0.75 of interest-bearing debt for every ₹1 of shareholders' equity.

Interest Coverage Ratio

Interest coverage measures the earnings available to meet interest costs.

Example: If profit before interest and tax is ₹150 lakh and interest expense is ₹30 lakh:

₹150 lakh ÷ ₹30 lakh = 5 times

A result below 1 means profit before interest and tax is lower than the interest expense for that period.

Market Ratios

Market ratios use financial information alongside market data to assess metrics related to a company's shares. They are mainly relevant to listed companies because they often depend on information such as the current market price per share.

Dividend Yield

Dividend yield shows the annual dividend per share relative to the current market price.

Suppose a company pays an annual dividend of ₹12 per share and the share trades at ₹600:

₹12 ÷ ₹600 × 100 = 2%

If the share price falls to ₹480 while the dividend remains ₹12, the yield rises to 2.5%. This does not automatically make the share more attractive, as the higher yield reflects a lower share price. Review earnings, cash flow, debt and dividend history when considering whether the dividend is sustainable.

Schedule III Financial Ratio Requirements

Companies reporting under Division I or Division II of Schedule III to the Companies Act must disclose 11 specified financial ratios. They must also explain the items included in the numerator and denominator and explain year-on-year changes of more than 25%.

Note that these 11 statutory ratios are not the same as the 13 commonly used financial ratios explained in this guide. The 13 ratios on this page are grouped for general financial analysis, while Schedule III specifies a separate disclosure list for covered companies.

For the complete list, disclosure rules and interpretation, read our guide to financial ratio analysis for business performance.

Conclusion

Financial ratios turn accounting data into practical information about cash, profit, inventory, customer credit and debt. Their value depends on consistent calculations, suitable comparisons and careful examination of the underlying accounts. No single ratio gives a complete view of a business, so related measures and operating conditions should always be considered together.

BUSY’s accounting software provides financial tools for balance sheets, profit and loss statements, trial balances, cash flow statements, and related reports. Businesses can use these figures to calculate ratios using consistent, clearly documented formulas.

You can also start a BUSY trial to review the available financial reports using your own business data.