Explain Functional classification
a) Liquidity ratio: these are the ratio which measures the short term solvency or financial position of a firm. These ratios are calculation to comment upon the short term paying capacity of a concem or the firm's ability to meet its current obligations. The various liquidity ratios are current ratio liquid ratio and absolute liquid ratio. Father to see the efficiency with which the liquid resources have been employed by a firm debtor s turnover and creditor's turnover ratios are calculated.
b) Long term solvency and leverage ratio: longer term solvency ratios convey a firm ability debt equity ratio interest coverage ratio and leverage ratio. Show the proportions of debt equity in financing of the firm. These ratios measure the contribution of financing by outsiders. The leverage ratios can further be classified as:
Financial leverage
Operating leverage
Composite leverage
c) Activity ratios: activity ratios are calculated to measure the efficiency with which the resources of a firm have been employed. These ratio are also called turnover ratios because they indicate the speed with which assets are being turned over into sales e.g., debtor turnover ratio. The various activity or turnover ratios have been named in the chart classifying the ratios.
d) Profitability ratios: these ratios measure the result of business operation or overall performance and effectiveness of the firm e.g., gross profit ratio or return on capital employed. The various profitability ratio have been given in the chart exhibiting the classification of ratios according to test. Generally two types of profitability ratios calculated are
In relation to sales and
In relation to investments