Accounting Ratio is one of the powerful tools of the financial analysis. It is an mathematical expression which shows relationship between two accounting items. It is an important yardstick for evaluating the financial position and performance of a business since the absolute data of a business cannot provide meaningful understanding and interpretation.
Accounting ratios can be expressed in various ways such as:
- A pure ratio like 2:1
- A rate like an accounting item is 2 times of other accounting item.
- A percentage like an accounting item is 10% of other accounting item.
Important accounting Ratios
Gross Profit Ratio: The ratio gives gross margin on trading.
(Gross Profit/ Net Sales ) X 100
Operating Ratio: The ratio gives the proportion that the cost of sales bears to sales.
(Cost of Goods Sold + Operating Expenses)/ Net Sales X 100
Operating Profit Ratio: It gives relationship between operating profit and sales.
Operating Profit/ Net Sales X 100
Here, Operating profit = Net profit + Non Operating Expenses – Non-Operating Income
= Gross profit – Operating Expenses
Net Profit Ratio: The ratio explains the per rupee generating capacity of sales.
= (Net Profit after Tax/ Net Sales) X 100
Return on Capital Employed: This ratio indicates the earning capacity of the capital employed in the business.
= (Operating Profit/ Capital Employed) X 100
Here, Operating profit is profit before interest and tax
Capital employed = Equity Share Capital + Preference Share Capital + undistributed profit + Reserves & surplus + Long term Liabilities – Fictitious Assets – Non Business Assets.
Alternatively you can also compute capital employed as follows:
Tangible Fixed and Intangible Assets + Current Assets – Current Liabilities.
Return on Shareholders’ Fund: It shows profitability from the point of view of the shareholders.
(Net Profit after interest and Tax/ Shareholders’ Fund) X 100
Return on Total Assets: It gives profit after tax against the amount invested in total assets to ascertain whether assets are being utilized properly or not.
(Net profit after Tax / Total Assets ) X 100
Earning Per Share: This shows the per share earning of the company and helps in estimating the company’s capacity to pay dividend to its shareholders.
(Net profit after tax / Number of Equity Shares) X 100
Her net profit after tax will include preference dividend, if any.
Price Earning Ratio: It shows market value of every rupee earning of the business.
Market price per equity share/ Earning per share
Dividend per equity share/ Earning per share
Retained Earning Ratio
(Retained Earning/ Total Earning ) X 100
Dividend Yield Ratio
(Dividend per Share/ Market price per Share) X 100
Current Assets/ Current Liabilities
Liquid Assets / Current Liabilities
Inventories and Prepaid expenses are not covered in Liquid assets.
Fixed Assets Ratio
Fixed Assets / Capital Employed
Debt Equity Ratio
Long Term Debts/ Shareholders’ Fund
Shareholders’ Fund/ Total Tangible Assets
Fixed Asset Ratio
Fixed Assets/ Capital Employed
Capital Gearing Ratio
Fixed Interest- bearing Securities/ Equity Shareholders’ Fund
Absolute Liquidity Ratio
(Cash at Bank + Marketable Securities)/ Current Liabilities
Marginal Contribution / Earning before interest & Tax
Earning before Interest and Tax / Earning before Tax
I will further update the article to give the importance of above ratios and include more ratio. You can ask any query on accounting ratios.