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Answer -
Ratios can be classified into two types:
1. Traditional Classification
2. Functional Classification
Traditional Classification: Traditional classification is based on the financial statements such as Balance Sheet and P & L Account. The ratios are divided on the basis of accounts of financial statements and are as follows:
i. Income Statement Ratios such as Gross Profit Ratios
ii. Balance Sheet Ratios such as Debt Equity Ratio, Current Ratio
iii. Composite Ratio: Ratios that contain elements from both Trading and P & L Account.
Functional Classification: These ratios are based on the functional need of calculating ratios. These ratio help calculate the solvency, liquidity, profitability and financial performance of a business. Such ratios are:
i. Liquidity Ratio: Ratios used to determine solvency of short term
ii. Solvency Ratio: Ratios used to determine solvency of long term
iii. Activity Ratio: Ratios used for determining operating efficiency of the business. These ratios are related to sales and cost of goods sold.
iv. Probability Ratio: Ratios used to determine financial performance and viability of the firm.