Some Financial Ratios In Accounting You Need To Know

        Financial Ratios 

 Financial Ratios

According to businessdictionary.com, financial ratio is a financial analysis comparison in which certain financial statement items are divided by one another to reveal their logical interrelationships. Some financial ratios are called primary because they indicate the fundamental causes underlying a company`s strengths and weaknesses. Others are called secondary because they depict the competitive position of a company and its financial structure as effects of the causes identified by the primary ratios.

A financial or accounting ratio is a relative magnitude of two selected numerical values taken from an enterprise's financial statements. As used in accounting, there are many ratios accountants use to evaluate the financial condition of an organization. Financial ratios can also be used by managers within a firm, by owners of a firm, and by creditors of the firm. Financial ratios are used by financial analysts to compare the strengths and weaknesses in various organizations.

Ratios can be expressed as decimal values, such as 0.10, 0.20 or expressed in equivalent value in percentage, such as 10%, 20%. Some ratios are usually expressed in percentages, especially ratios that are usually less than 1 while others are usually expressed in decimal numbers, such as ratios that are usually more than 1. Those that are usually more than 1 are also called multiples. Every ratio has its own reciprocal; if the ratio was above 1, the reciprocal will surely be below 1, and vice versa. The reciprocal always expresses the same information, but may be more comprehensible: for example, the earnings yield can be compared with bond yields.

Read Also: Mathematics Of Finance

 Categories of financial ratio include the following:

1. Profitability ratio
2. Liquidity ratio
3. Efficiency ratio
4. Shareholders ratio
5. Capital structure ratio

Profitability Ratio: It look deeply at the viability.
  Return on capital employed: It is one the most important profitability ratios as it includes all other ratios and people invest their money in a business because of an adequate return on capital employed.
It is calculated using the formula:

    ROCE = net profit          

                 Capital employed

Other profitability ratios are listed with their formulae below;

Gross profit margin = gross profit

                                        Sales             

Profit margin = net profit

                             Net sales

Operating margin or return on sales = operating income 

                                                                       Net sales

Return on equity = net income  

                           Average shareholders equity 

Return on assets = net income 

                               Total assets 

Net gearing = net debt

                        Equity     

 Liquidity Ratio: It tends to look at the financial stability of business. It measures the availability of cash to pay debt.
current ratio = current assets
                       current liabilities
Acid-test ratio = current assets - (inventories + prepayment)
                                  current liabilities 
 Cash ratio = cash and marketable 
                        current liabilities

Efficiency Ratio: It measures the effectiveness of the firm`s use of resources.
stock turnover = cost of goods sold
                            average stock 
debtors ratio = debtors
                          sales 
creditors ratio = creditors 
                         purchases

Investors or Market Ratio:
earning per share = net profit after tax 
                            number of shares issued
price earning = market price per share 
                                 earning  
dividend yield per share = dividend per share
                                         market price per share
dividend cover =  net profit after tax                    
                     ordinary dividend paid & proposed

Capital Structure Ratio:
gearing ratio =   debt    
                        equity        
 equity here refers to shareholders fund.