Accounting ratios - a complete list
/What are Accounting Ratios?
Accounting ratios are those ratio comparisons that can be derived solely from the financial statements. They are used to form conclusions regarding the liquidity, leverage, profitability, and working capital usage of a business. All of these ratios can then be compared to the results from prior periods, as well as the same information reported by competitors, to judge the relative position of a company. The essential accounting ratios are noted below.
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The Interpretation of Financial Statements
Liquidity Ratios
The most-recognized liquidity ratio is the current ratio, which compares current assets to current liabilities. If the amount of current assets significantly exceeds the amount of current liabilities, then this is an indicator that a firm has sufficient resources to pay off its immediate obligations. The current ratio formula is as follows:
Current assets ÷ Current liabilities = Current ratio
The quick ratio is the best liquidity ratio. It compares all current assets except inventory to current liabilities. Inventory is excluded from the comparison, because it can be difficult to convert to cash. The purpose of the quick ratio is to see if a business has enough assets that can be reasonably converted into cash to meet its current obligations. The quick ratio formula is as follows:
(Cash + Marketable securities + Accounts receivable) ÷ Current liabilities = Quick ratio
The most conservative liquidity ratio is the cash ratio, which compares only a firm’s cash and cash equivalents to its current liabilities. It excludes inventory (which is included in the current ratio) and accounts receivable (which is included in the quick ratio). This ratio may be too conservative, especially if receivables are readily convertible into cash within a short period of time. The cash ratio formula is as follows:
(Cash + Cash equivalents) ÷ Current liabilities = Cash ratio
Leverage Ratios
The relative debt load of a business is its leverage, which is best measured with the debt-equity ratio. This ratio compares the total amount of all types of debt to the total amount of equity appearing on the balance sheet. The purpose of the debt-equity ratio is to see if a business is properly balancing the amount of funding raised from stock sales to the amount of funding raised from debt. A high ratio may not be supportable if a company's cash flows are not consistent enough to make periodic interest and principal payments on its debt. The debt-equity ratio formula is as follows:
(Long-term debt + Short-term debt + Leases) ÷ Equity = Debt to equity ratio
Profitability Ratios
The net profit ratio is the ultimate measure of profitability. It compares the net, after-tax earnings of a business to its net sales. The purpose of the ratio is to see if a business is being efficient with its expenditures to create products that can be sold at reasonable price points. The net profit ratio formula is as follows:
(Net profit ÷ Net sales) x 100 = Net profit ratio
Working Capital Ratios
The primary indicators of working capital usage are receivables turnover, inventory turnover, and payables turnover. High rates of turnover for receivables and inventory indicate that a company is maximizing its use of cash by having minimal assets outstanding in these areas. Conversely, a low payables turnover rate is considered better, since it implies that a business is maximizing the loans extended to it by its suppliers via outstanding invoices. The ratio calculations are:
Receivables turnover. Net annual credit sales divided by average receivables.
Inventory turnover. Annual cost of goods sold divided by average inventory.
Payables turnover. Annual purchases from suppliers divided by average payables.