Accounting Ratios

Accounting ratios are numerical values derived from a business's financial statements. They are used to evaluate various aspects of a company's financial stability, performance, and liquidity. Here are some common categories of accounting ratios:

Liquidity Ratios: These measure a company's ability to meet its short-term obligations. Examples include:

Current Ratio: Total current assets divided by total current liabilities.

Quick Ratio (or Acid-test Ratio): (Total current assets minus inventory) divided by total current liabilities.

Solvency Ratios: These assess a company's capacity to sustain operations indefinitely by examining its debt levels in relation to its assets and equity. Examples include:

Debt to Equity Ratio: Total liabilities divided by shareholders' equity.

Debt to Asset Ratio: Total liabilities divided by total assets.

Profitability Ratios: These evaluate how effectively a company can generate profit relative to sales, assets, or equity. Examples include:

Gross Profit Margin: (Sales minus the cost of goods sold) divided by sales.

Return on Assets (ROA): Net income divided by total assets.

Return on Equity (ROE): Net income divided by shareholders' equity.

Efficiency Ratios: These ratios measure how effectively a company uses its assets and manages its operations. Examples include:

Asset Turnover Ratio: Sales divided by average total assets.

Inventory Turnover Ratio: Cost of goods sold divided by average inventory.

Market Value Ratios: These provide insight into how investors view the company’s financial health and future performance. Examples include:

Price to Earnings Ratio (P/E): Market price per share divided by earnings per share.

Dividend Yield: Annual dividends per share divided by the price per share.

These ratios are essential tools for investors, creditors, and company management to make informed financial decisions and assess the health of the business.