Principles of Accounting: Introduction to Accounting ratios

Introduction to ratios in Accounting

• Often in business numbers given in isolation are difficult to interpret
• For example Business A makes a profit of $10 000 while Business B makes a profit of $10 million
• It would be difficult to know which business better between the two
• Those new to Accounting and Finance in general might be tempted to say Business B at a glance
• To disprove this notion consider for example that Business A has a Capital Employed of $5 000 while Business B has a Capital Employed of $10 billion
• Clearly Business A was more successful in utilising its capital compared to Business B
• To help and analyse and interpret accounting data Accountants make use of ratios
• Ratio-is a result of one number when it is divided by another
• Ratios can be expressed:
  1. As a percentage for example 10%
  2. As a fraction \frac{10}{100}
  3. As a decimal e.g 0.10
  4. In traditional ration/scale format e.g. 10:100
  5. In words ten as to one or even one in ten
• Ratios are commonly used to:
  1. interpret accounting information,
  2. analyse accounting information,
  3. evaluate a business’s performance
  4. compute missing information
  5. in budgeting and forecasting
• There are three common types of ratios:
  1. Profitability ratios
  2. Liquidity ratios
  3. Efficiency ratios
• Just click on each group of ratios to learn more about it
• Please note we will not look at efficiency ratios at this level their inclusion in this discussion are for purely informational purposes

To access more topics go to the Principles of Accounting Notes.