What are various types of ratios?
Ratios are classified into two main categories:
1. Traditional Classification: This classification is based on the financial statements to which the determinants of ratios belong.
2. Functional Classification: Under this classification, ratios are categorised as:
- Liquidity ratios (e.g., current ratio and acid test ratio)
- Solvency ratios (e.g., debt equity ratio, total assets to debt ratio)
- Activity ratios
- Profitability ratios
Solvency ratios are specifically calculated to determine the ability of the business to service its debt in the long run rather than in the short run.
Explanation
The textbook clearly states that there is a two-way classification of ratios: traditional and functional. The functional classification is more commonly used and includes four types - liquidity, solvency, activity, and profitability ratios. The context specifically mentions liquidity ratios (current ratio and acid test ratio) and solvency ratios (debt equity ratio, total assets to debt ratio) with examples. This 3-mark answer covers both classification methods and provides examples where available in the text.