Accounting ratios, also known as financial ratios, are used to evaluate a business’s financial performance and position. Additionally they are used by investors, analysts, and management to assess the profitability, liquidity, solvency, and efficiency of the business. The ratios are a relative measure of two or more values taken from the financial statements of a business and can be expressed as a decimal value such as 0.45 or as a percentage e.g. 45%.
The site does not aim to list all possible ratios as many are not relevant to the smaller business, but is does give what are considered to be the most important and commonly used ratios used in managing a business.
Accounting Ratios Analysis
Accounting ratios are used to analyse business trends and measure performance of both the business and the management.
One accounting ratio viewed in isolation will not tell you a great deal about a business. Accordingly the key to using accounting ratios is to chose the ratios which are most critical to your business, decide on the formula to use, which should be the same as that used by comparable businesses in your industry, and consistently monitor the ratio over time relative to other ratios you have calculated.
Ratios in Accounting
Accounting ratios can be split into six main categories
- Profitability Ratios: These ratios measure the ability of a business to generate profits. Examples include gross profit margin, net profit margin, return on assets, and return on equity.
- Liquidity Ratios: These ratios measure the ability of a business to meet its short-term obligations. Examples include current ratio, quick ratio, and cash ratio.
- Efficiency ratios: These ratios measure how effectively a business is using its assets and resources. Examples include inventory turnover ratio, accounts receivable turnover ratio, and asset turnover ratio.
- Leverage Ratios: These ratios show the capital structure of a business and in particular the level of debt and equity.
- Activity ratios: These ratios are used to measure the ability of a business to convert different balance sheet accounts such as inventory, account receivable, and accounts payable into cash or sales.
- Investor ratios: These ratios are used to measure the ability of a business to earn an adequate return for the owners of the business.
Popular Ratio Formulas
A selection of popular ratios from the Accounting Ratios Formulas Guide.
- Asset Turnover Ratio
- Cash Flow Ratio Analysis
- Cash Flow Ratios Calculator
- Creditor Days Ratio in Accounting
- Current Ratio
- Days Sales Outstanding
- Debt Equity Ratio
- Debtor Days Ratio
- Fixed Asset Turnover Ratio
- Gearing Ratio Analysis
- Gross Profit Percentage
- Interest Coverage Ratio
- Inventory Days
- Net Profit Ratio
- Operating Leverage Ratio Analysis
- Overhead Ratio
- Quality of Earnings Ratio
- Quick Ratio or Acid Test Ratio
- Return on Assets ROA
- Return on Equity – ROE
About the Author
Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a degree from Loughborough University.