Accounting And Forecasting

In order to see the bigger picture of a company's financial health ratios are used to measure liquidity, activities, debt, and profitability. There are two ratios used in the liquidity ratio category, the first one is the current ratio which measures liquidity, the other is the quick (acid test) ratio which also measures liquidity but just a different formula and different meaning for the investors and banks. Current ratio = current assets / current liabilities to where as the quick ratio = current assets - inventory / current liabilities (Gitman, 2006). The current ratio tells whether the firm has the ability to meet their short-term obligations and the quick ratio also does the same but excludes the inventory for the simple fact that inventory will become account receivables or it can't be sold.

In the activity ratio category there are several different ratios used. The first one is the inventory turnover which measures the activity of inventory, inventory turnover = cost of goods sold / inventory (Gitman, 2006). Another ratio used in this category is the average collection period which measures the time that is needed to collect accounts receivable. This ratio is great for evaluating credit. The next ratio is the average payment period which measures the time that is needed to pay account payables. This ratio great for seeing the relation to the average credit terms that are extended to the firm. Last but not least the total asset turnover is used to measure the efficiency of a firm using its assets to generate sales. Management would be interested on such ratio for the fact that it does indicate if the operations of the firm have been efficient financially.

In the debt ratio category there are also several ratios used. The first one mentioned is the degree of indebt ness which measures the relation between amounts of debt and balance sheet amounts which is done with the debt ratio. Over the life of the debt the ability to make the scheduled payments is measured by ability to service debt. Coverage ratios measure the ability of a firm's ability to pay certain fixed charges. The debt ratio measures the total assets proportion by the creditors of the firm. Debt ratio = total liabilities / total assets (Gitman, 2006). If the results are high then the firm has a better financial leverage. In order to measure the firm's ability to make their interest payments that are contracted they use the times interest earned ratio, times interest earned ratio = earnings before interest and taxes / interest (Gitman, 2006). Lastly in order to measure the firm's ability to meet all their fixed payment obligations they use the fixed-payment