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Accounting Ratios

The document discusses accounting ratios as a tool for analyzing a corporation's financial health, focusing on liquidity, profitability, and efficiency ratios. It provides formulas and examples for key ratios such as the Current Ratio, Acid Test Ratio, Gross Profit Margin, and Net Profit as a Percentage of Sales. Additionally, it covers efficiency ratios like Rate of Turnover and collection/payment period ratios to assess resource utilization.

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Kaicha Byfield
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13 views21 pages

Accounting Ratios

The document discusses accounting ratios as a tool for analyzing a corporation's financial health, focusing on liquidity, profitability, and efficiency ratios. It provides formulas and examples for key ratios such as the Current Ratio, Acid Test Ratio, Gross Profit Margin, and Net Profit as a Percentage of Sales. Additionally, it covers efficiency ratios like Rate of Turnover and collection/payment period ratios to assess resource utilization.

Uploaded by

Kaicha Byfield
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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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

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