Explain briefly the significance of any four types of ratio that the management of every firm is interested in.

Answer 2(b) 1. Profitability Ratios Operating profit margin (OPM) and Net Profit Margin (NPM) are calculated by dividing the figures of operating profit (EBIT) which means earnings before interest and tax and net profit respectively by the net sales. OPM is an indicator of the operating efficiency of the enterprise while NPM is an indication of ability to withstand the adverse business conditions. 2. Liquidity Ratios These are Current Ratio (CR) and Quick Ratio or Acid Test Ratio. While the CR is a ratio of total current assets to total current liabilities, quick ratio is calculated by dividing current assets (excluding inventory) by total current liabilities. These ratios indicate the capacity of an enterprise to meet its short term obligations. 3. Capital Structure Ratios Debt Equity Ratio (DER) is a ratio of total outside long term liability to the Net Worth of an enterprise. High debt equity ratio are an indication of high borrowings in relation to the owned funds. It also affects the viability of the operation of the enterprise, as higher borrowings means higher costs and lower operating margins. In case of those enterprises, which are not capital intensive (i.e. the requirement of fixed assets is low), which are not indicated by DER, may be disproportionate to the capital. To get a better result, OL/TNW ratio i.e. the ratio of total out side liabilities to tangible Net Worth can be used. 4. Inventory Turnover Ratio This is one of the important ratios to measure the skills of the management of the firm. This is an indicator of how fast or slow is the movement of inventory. It is calculated by dividing cost of goods sold by average inventory. A higher ratio indicates faster movement of inventory. This is also used for calculating average inventory holding period.