Accounting or financial ratios are the relationship between two categories of a financial statement analysis. They form the basis of fundamental analysis because they provide us with information related to operating effectiveness which can lead to better planning for research, management, production costs, etc.
For example, if we look at a company’s current assets and current liabilities and divide the first one over the second one, we will get an accounting ratio, known as a current ratio. The purpose of the current ratio is being able to compare a particular company’s information with past years or with other companies and identify weaknesses and strengths.
Computing Accounting Ratios
It is important for accountants to keep in mind that accounting ratios are one way of comparing the financial performance of companies across a specific industry. Because accounting ratios don’t take into consideration the company’s size and industry, it is just a simple mathematical comparison based on proportions given by the numbers previously mentioned.
In addition, financial ratios and financial statement analysis have limitations, which is why accountants must realize that the financial ratio can be positive or negative depending on the industry and the field that’s being studied.
Other examples of accounting ratios include quick ratio, current ratio, debt to equity ratio, acid-test ratio, contribution margin ratio, interest coverage ratio, debt to total assets ratio, gross margin ratio, return on assets ratio, profit margin (after tax) ratio, total assets turnover ratio, fixed asset turnover ratio, times interest earned ratio, liquidity ratio, working capital ratio, dividend payout ratio and free cash flow ratio.