Learning the various classes of ratios

There are thousands of ratios and we could easily get carried away with them. However, ratios can be classified into five broad categories:

• Profitability
• Liquidity
• Efficiency
• Debt management
• Market ratios

We will examine a few examples from each of these categories in the following sections.

Profitability

These ratios measure how capable a company is at converting turnover into profit. Profitability ratios are usually referred to as margin, which generally means divided by turnover. So, we have the gross profit margin, calculated as follows:

Gross profit is the turnover less cost of sales. Sometimes, when a company makes a loss, you can still take some comfort if there is a gross profit. This means that the direct costs have been covered and there is some contribution toward overheads or administrative expenses. Once a company has been in business for a number of years, the gross...