Accounting ratios tell the

story of financial health

Liquidity Ratios
There are two accounting ratios that measure a units liquidity. These equations use the
values reported in the Balance Sheet.

The first ratio is called Current Ratio. This ratio answers the question, Can the current
assets pay the current liabilities. Yes is the answer if the current ratio is greater than
or equal to 1.0. A value of 2.0 should be the target. This provides some cushion.

Current Ratio = Current Assets / Current Liabilities

Equation 1: Current Ratio

Another liquidity ratio used is called the Quick Ratio. It is a conservative ratio reporting if
there is enough cash and receivables to pay the bills due in 12 months.

Quick Ratio = (Cash + Accounts Receivable) / Current Liabilities

Equation 2: Quick Ratio

Asset Management Ratios

There are three accounting ratios that measure a units ability to effectively use their
assets to produce income. These equations use the values reported in the Income
Statement and Balance Sheet.

The first ratio is Asset Turn Ratio. A measure of how well a unit is using its assets to
make sales.

Asset Turn = Net Sales / Total Assets

Equation 3: Asset Turn Ratio

At times one may want to know how long does it take on average to get paid for a
product sold? The ratio used to answer that question is called Receivable Days.

Receivable Days = 365(Accounts Receivable) / Net Sales

Equation 4: Receivable Days

The last ratio measures how fast one is using the inventory.

Inventory Turn = Cost of Goods / Inventory

Equation 5: Inventory Turn

Profitability Ratios
How well is management doing at making profits for its owners. There are four
accounting ratios that answer this question. The ratios use the values reported in the
Income Statement and Balance Sheet.
The first ratio measures how well management is doing at using the assets to make a
profit. This measurement is called Return on Assets (ROA).

ROA = Net Income / Total Assets

Equation 6: Return on Assets

Now lets look at another ratio to determine how well management is using money
invested by shareholders. This is ratio is called Return on Equity (ROE) or Return on
Investment (ROI).

ROI = Net Income / Shareholder's Equity

Equation 7: Return on Equity or Return on Investment

Next lets determine the profit margin of a company. Also called Return on Sales (ROS).

ROS = Net Income / Net Sales

Equation 8: Return on Sales "Profit Margin"

The last profitability ratio is Gross Margin, the percentage of profit over the cost of
goods.

Gross Margin = (Net Sales - Cost of Goods) / Net Sales

Equation 9: Gross Margin "Gross Profit"

Leverage Ratios
Does a unit operate with too much debt? There are two accounting ratios that answer
this question. From the Balance sheet these ratios are calculated.

Does a unity have more debt than equity? Will a company be able to repay a loan out of
their equity? This is answered with the Debt-to-Equity Ratio (DTE).

DTE = (Current Debt + Long-Term Debt) / Shareholder's Equity

Equation 10: Debt-To-Equity Ratio

The second ratio compares debt to assets.

Debt Ratio = (Current Debt + Long-Term Debt) / Total Assets

Equation 11: Debt Ratio

In summary, you now know the 11 basic accounting ratios that compares a units
performance. Measuring how well they produce more with less. Liquidity and leverage
ratios report the future survival of a company. Investors determine future success with
profitability ratios. With this knowledge you can now determine the financial health of a
person or business.