Accounting Ratios

Accounting ratio is for the comparison of two or more financial data that are being used for analysing the financial statements of the companies. Accounting Ratios is an effective tool that is used by the shareholders, by the creditors and by all kinds of stakeholders or the interested parties to the organization. The comparison is done to understand the profitability, strength and the financial status of the companies.

Another name for the accounting ratios is the ‘financial ratios’ which are based on the business performance that can be monitored and is important to make the business decisions that are being made.

Types of Ratios

The main concern of the discussion is that the types of ratio are to be analysed here which will help the business entities to compare their own reporting statements.  Following are the types of ratios which will help the business concern to function effectively by comparing their statements. 

1. Liquidity Ratios:

This ratio helps in measuring the cash sufficiency that is available with the enterprise, which will help them to pay off its short-term liabilities. A good and high liquidity ratio facilitates the company that it is in a good position to pay its creditors, the money on time.  2 or more as the ratio is considered acceptable. The commonly used liquidity ratios are the –

  • Current Ratio

  • Quick Ratio

  • Cash Ratio

2. Profitability Ratios:

Profitability ratio is normally used to determine how the business is generating the profits from its operations. Profit is the main concern of the business organizations, that is the balance of income which is earned after deducting all its related expenses. These are the profitability ratios in use:

  • Gross Profit Margin

  • Operating Margin

  • Profit Margin 

  • Earnings Per Share

3. Leverage Ratio:

Leverage ratio is the measure of the utilization of the borrowed money that is borrowed by the business, which helps to identify the financial stability of the business by analysing the total debt of the company. The ratios used here are:

  • Debt-to-Equity Ratio

  • Debt-to-Asset Ratio

  • Debt Ratio

  • Interest Coverage Ratio

4. Activity Ratio:

Activity ratio is the one which indicates the return that is generated from a particular type of asset using the sales, cost and asset data. Activity ratio helps the business to identify the effective utilization of the assets and thereby facilitates their efficient management system. The types of ratio are:

  • Receivable Ratio

  • Inventory Turnover Ratio

  • Asset Turnover Ratio

Accounting Ratio Formula

In this section we will enunciate the list of formulae which is valid in this discussion.

Following are the formulae which will help the business concern to compare their financial statement. 

  • Current Ratio = Current Assets/ Current Liabilities

  • Quick Ratio = Quick assets/ Current Liabilities

  • Operating Margin = Gross Profit – Operating Expense/ Revenue

  • Profit margin = Revenue – Operating Expenses + Non-Operating Income – Interest Expense - Income Taxes/ Revenue

  • Earnings per Share = Net Income – Preferred Dividend/ Weighted Average Outstanding Shares

  • Debt Ratio = Total Liabilities/ Total Asset

  • Receivable Ratio = Annual Sales Credit/ Accounts Receivable

  • Asset Turnover Ratio = Net Revenue/ Assets

Here the ratios which are discussed have a justifiable and special significance of each all. All the ratios have a significance of their own which help the business to Each ratio have significance of their own, which help the companies to compare their own statements, this will help them to detect their shortcomings and growth perspective via which they can communicate the same to the interested parties who are willing to invest in the business concern. 

FAQs (Frequently Asked Questions)

1. What are Financial Statements?

Ans.  Financial statements are the written records that communicate the business activities and the financial performance and also the position of the company. Financial statements are generally audited by the government agencies, accountants, firms, etc. this is done to ensure the accuracy of the statement so that it can be utilised for tax purposes, financing, or for investing purposes. The financial statements include:

  • Balance sheet

  • Income statement

  • Cash flow statement.

The objectives of the financial statements are to show an accurate state of a company's economic assets and liabilities. The statements provide information which relates to the company's cash flows position.

2. Who are the Stakeholders of the Business?

Ans. A stakeholder is one who has a vested interest in a company or business, which can either affect or be affected by a business' operations and its performance. General stakeholders are the investor group, employees of the company, customers section, supplier’s department, communities, governments, and also the trade associations.

Stakeholders may also be the investor in the company and their actions might determine the outcome of the company. These stakeholders play an important role in defining the future of the company as well as its daily workings.

3. How is Quick Ratio Different From Current Ratio?

Ans. The current ratio is the proportion or the quotient or the fraction of the amount of current assets that is divided by the amount of current liabilities. While, the quick ratio or the acid test ratio is the proportion of only the most liquid current assets available to the amount of current liabilities.

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