This article provides an overview of important accounting ratios and formulas.

Test of Liquidity

Ratios to Calculate

1. Current ratio
Formula:
= Current assets / Current liabilities
2. Quick ratio (or acid test ratio or liquid ratio) (for immediate solvency)
Formula:
= (Liquid assets/Quick assets) / Current liabilities
3. Absolute liquid ratio
Formula:
= Absolute liquid assets / Current liabilities

Current Assets Movement or Activity Ratios

Ratios to Calculate

1. Inventory stock turnover ratio
Formula:
= Cost of goods sold / Average inventory at cost
2. Debtors or receivables turnover ratio/velocity
Formula:
= Net annual credit sales / Average trade debtors
3. Average collection period
Formula:
= Total trade debtors / sales per day
4. Creditors/payable/turnover ratio/velocity
Formula:
= Net annual credit purchases / Average trade creditors
5. Average payment period
Formula:
= Total trade creditors / Average daily purchase
6. Working capital turnover ratio
Formula:
= Cost of sale / Net working capital

Analysis of Long-Term Financial Position or Test of Solvency

Ratios to Calculate

1. Debt-to-equity ratio
Formula:
= Outsiders’ funds / Shareholders’ funds
Or
= External equities / Internal equities
2. Funded debt to total capitalization ratio
Formula:
= (Funded debt x 100) / Total capitalization
3. Ratio of long-term debt to shareholders’ funds (Debt-Equity)
Formula:
= Long-term debt / Shareholders’ funds
4. Proprietary or equity ratio
Formula:
= Shareholders’ funds / Total assets
5. Solvency ratio
Formula:
= Total liabilities to outsiders / Total assets
6. Fixed assets net worth ratio
Formula:
= Fixed assets after depreciation / Shareholders’ funds
7. Fixed assets ratio or fixed assets to long-term funds
Formula:
= Fixed assets after depreciation / Total long-term funds
8. Ratio of current assets to proprietor’s fund
Formula:
= Current assets / Shareholders’ funds
9. Debt service or interest coverage ratio
Formula:
= Net profit before tax/interest / Fixed interest charges
10. Total coverage or fixed charge coverage
Formula:
= FBIT / Fixed Assets

Analysis of Profitability

A. General Profitability

Ratios to Calculate

1. Gross profit ratio
Formula:
= (Gross profit x 100) / Net sales
2. Operating ratio
Formula:
= (Operating cost x 100) / Net sales
3. Expense ratio
Formula:
= (Particular expense x 100) / Net sales
4. Net profit ratio
Formula:
= (Net profit after tax x 100) / Net sales

B. Overall Profitability

Ratios to Calculate

1. Return on shareholders’ investment or net worth
Formula:
= Net profit (after interest & tax) / Shareholders’ funds
2. Return on equity capital
Formula:
= Net profit after tax / Average shareholders’ equity
3. Earnings per share
Formula:
= Total earnings / outstanding shares
4. Return on gross capital employed
Formula:
= (Adjusted net profit x 100) / Net capital employed
5. Return on net capital employed
Formula:
= Net operating profit / Net capital employed
6. Dividend yield ratio
Formula:
= Dividend per equity share / Market value per share
7. Dividend payout ratio or payout ratio
Formula:
= Dividends / Net Income
8. Price-to-earnings ratio
Formula:
= Market price per share / Earning per share

Analysis of Capital Structure or Leverage

Ratios to Calculate

1. Capital gearing ratio
Formula:
= Common stockholders’ equity / Fixed cost bearing fund
2. Total investment to long-term liabilities
Formula:
= Shareholders’ funds + Long-term liabilities / Long-term liabilities
3. Debt-to-equity ratio
Formula:
= Total liabilities / Total equity
4. Ratio of fixed assets to funded debts
Formula:
= Fixed assets / Funded debt
5. Ratio of current liabilities to proprietor’s funds
Formula:
= Outsiders’ funds / Shareholders’ funds
6. Ratio of reserves to equity capital
Formula:
= (Reserves x 100) / Equity share capital
7. Financial leverage
Formula:
= EBIT / (EBIT – Interest & Preference dividend)
8. Operating leverage
Formula:
= Contribution / EBIT

Frequently Asked Questions

What are the types of accounting ratios?

The main types of accounting ratios are: - Liquidity ratios - Efficiency or activity ratios - Financial leverage ratios - Profitability ratios

Which ratio is used to measure a company’s ability to pay its short-term obligations?

The liquidity ratio is used to measure a company’s ability to pay its short-term obligations. The most common liquidity ratios are the current ratio and the quick ratio.

What is the formula for calculating the working capital turnover ratio?

The working capital turnover ratio is calculated by dividing the cost of sales by the net working capital.

What is the debt service coverage ratio?

The debt service coverage ratio is a measure of a company’s ability to meet its fixed debt payments. The formula for calculating the debt service coverage ratio is net income before interest and tax divided by fixed interest charges.

What is the Price-to-Earnings (P/E) ratio?

The price-to-earnings (P/E) ratio is a measure of how much investors are willing to pay for each dollar of a company’s earnings. The P/E ratio is calculated by dividing the market price of a share by the earnings per share.

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