Accounting Ratios
Ratio Analysis
• It is possible to look at the financial health of a corporation by looking
at some of its key financial ratios. Ratio analysis can also be used as a
diagnostic tool to find the sources of financial trouble at a company.
What is an Accounting Ratio
• The use of accounting ratios is a technique commonly used to analyse
an entity’s financial position and performance.
• Analysis of financial statements involve using information presented to
assess the performance of the entity to achieve informed decision
making.
Liquidity Ratios
• This assesses the business’ ability to cover its short-term debt as they
become due.
• These ratios focus on the availability of cash to manage the day to day
operations of the company.
Current Ratio
• The current ratio of a company gives us a quick way to look at its
current assets and current liabilities. They should be nearly equal to one
another.
Current Ratio = Total Current Assets
Total Current Liabilities
Also known as “Working Capital Ratio” Ratio expressed as the number of
times current assets can cover the current liabilities in the accounting
period.
Example
If the current assets of a business is $12,500 and the currents liabilities is
$5000, what is the Current Ratio.
Current Ratio = Current Assets = $12 500 = 2.5:1
Current Liabilities $5 000
• The business has 2.5 Current assets to cover 1 Current liability
Acid Test Ratio/Quick Ratio
• Ratio expressed as the number of times quick assets can cover the
current liabilities in the accounting period.
Acid Test Ratio = Current Assets – Stock
Current Liabilities
Example
$
Stock 2500
Current Assets 12500
Current Liabilities 5000
Calculate Acid Test Ratio.
• Current Assets - Stock = $12 500 - $2 500 = 2:1
Current Liabilities $5 000
• The business has 2 Quick Assets cover 1 Current Liability
Profitability Ratios
• This assesses the business’ overall efficiency and performance during a
specific period.
• It measures the degree of accounting profits.
Gross Profit as a Percentage of Sales
• Expressed as a % Amount of Sales that result in Gross Profit
Gross Profit as a Percentage of Sales/Gross profit margin
= Gross Profit x 100
Net Sales
Example
$
Gross Profit 12,900
Sales 32,000
Calculate the Gross Profit Margin.
• Gross Profit x 100 = $12 900 x 100 = 40.3%
Net Sales $32 000
The business made a Gross profit of $0.40 for every $1 of Sales.
Net Profit as a Percentage of Sales
• Expressed as a percentage (%) amount of Sales that business keeps as
profits after cost of sales and expenses.
Net Profit as a Percentage of Sales = Net Profit x 100
Net Sales
Example
$
Net Profit 7,200
Sales 32,000
What is the Net Profit as a percentage of Sales?
• Net Profit x 100 = $7 200 x 100 = 22.5%
Net Sales $32 000
• The business made a profit of $0.22 for every $1 of Sales after deducting all
costs & expenses.
Net Profit as a Percentage of Capital Employed
(Return on Capital Employed)
• This ratio measures the amount of returns a business receives from
resources made available to them from funds supplied by owners.
Sometimes, funds supplied by creditors (long term liabilities) are
included in capital employed as well.
Net Profit as a Percentage of Capital
Capital Employed = Opening Capital + Closing Capital
Employed = Net Profit x 100
2
Capital Employed
Example
• Net Profit x 100 = $7 200 x 100 = 33.3%
Capital Employed $21 600
The business earned $0.33 for every $1 of Capital Employed.
Example
$
Closing Stock 1500
Opening Stock 3100
Cost of Sales 19,100
What is the Rate of Turnover
Rate of Turnover or Stock turnover = Cost of Goods Sold = 19,100
Average Stock 1500+3100/2
$19 100 = 8.3 times
$2 300
Mark-up
Mark-up = Gross Profit x 100
Cost of sales
Expenses as a percentage of Revenue
Expense as a percentage of revenue = Expenses x 100
Sales/revenue
Efficiency Ratios
⚫ Efficiency ratios tells how well a business uses resources, that is, how
quickly you sell inventory, collect payments, or generate revenue from
assets.
Rate of Turnover or Stock turnover
• Expressed as the number of times per annum stock is sold or turned
over.
Rate of Turnover or Stock turnover = Cost of Goods Sold
Average Stock
Average Stock = Opening Stock + Closing Stock
2
Collection/Payment Period Ratios
Receivables collection Period= Accounts receivables/Debtors x 365
Credit sales
Payables payment Period= Accounts payable/Creditors x 365
Credit purchases
