Vedaniti, Lear UNE Online Types of Ratio IMD Join vedantu's FREE Mastercalss Join now Accounting Ratios Meaning Accounting ratios are an important business tool for analyzing financial statements. A ratio is defined as a mathematical number that can be calculated with respect to the relationship of two or more numbers and can be expressed as a ratio, percentage, and fraction. When a ratio is calculated by relating two accounting numbers derived from the financial statements it is termed as an accounting ratio or financial ratio. It should be noted that accounting ratios represent the relationship between if any, the accounting numbers derived from the financial statement. Accounting ratios are essentially derived from the financial statements and their efficiency largely depends on the original numbers from which they are calculated. Therefore if there are any errors found in the financial statements the derived numbers in relation to the ratio analysis would also present an incorrect imprecise situation. Therefore the ratios must be calculated using the numbers which are meaningfully associated because a ratio calculated using the two unrelated numbers would hardly serve any purpose. For example, the office furniture is Rs. 5,00,000 and their purchase is 10,00,000. The ratio of office furniture to purchase is 2 (5,00,000/10,00,000) but it hardly served any purpose as there is no relationship between the two aspects. Whatare AccountingRatios? Accounting ratio, also known as the financial ratio, is the comparison of two or more financial data which are used to evaluate a business condition. It is an effective business tool that is used by shareholders, creditors, and all kinds of stakeholders to understand the profitability, strength and financial status of a business. Accounting ratios are also widely used to examine business performance and accordingly business decisions can be made. Whatare the Different Types of AccountingRatios?Vedaniti, Lear UNE Online Ratios are classified into two types namely traditional classification and functional classification. The traditional classification is based on the financial statement to which the determinants belong. Based on the traditional classification, ratios are classified as: 1. Statementof Profit and Loss Ratios: A ratio of two variables from the profit and loss statementsis termed the statement of profit and loss ratio. For example, the ratio of gross profit to revenue generated from business operations is referred to as the gross profit ratio. It is calculated using both the figures derived from the profit and loss statement 2. Balance Sheet Ratios: If both the variables of the ratios are from the balance sheet, then it is classified as the balance sheet ratios. For example, the ratio of current assets to current liabilities is termed the current ratio. It is calculated using both the figures derived from the balance sheet. 3. CompositeRatios: If the ratios are calculated using one variable from the financial statement and another variable from the balance sheet, then it is termed composite ratios. For example, the ratio of credit revenue from business operations to trade receivables is termed the trade receivable turnover ratio. It is calculated using one variable from the profit and loss statement (credit revenue from business operations) and another variable (trade receivables) from the balance sheet statement. On the Basis of Functional Classification, Ratios Are Classified as: 1. Liquidity Ratios: To meet business commitments the business needs liquid funds. The ability of a business to pay the due amount to stakeholders as to when it is due is known as liquidity, the ratios calculated to measure it are known as liquidity ratios. The liquidity ratios are short-term in nature. They are calculated to measure the short-term solvency of the business i.e. the firm's ability to meet its current obligations. The most common type of liquidity ratios are: * Current Ratio * Quick or Liquid RatioLear UNE Online 2. Solvency Ratio: The business solvency is determined by its ability to meet its contractual obligations towards stakeholders, specifically towards external stakeholders, and the ratios calculated to measure the business solvency positions are known as the solvency ratio. The solvency ratios are long-term in nature. The most common type of solvency ratio for calculating the business solvency are: * Debt-Equity Ratio * Debt to Capital Employed Ratio * Proprietary ratio * Total Asset to Debt Ratio + Interest Coverage Ratio » . Activity or Turnover Ratio: These are the ratios that are calculated for measuring the efficiency of business operations based on the effective utilization of resources. Hence, these are also termed efficiency ratios. A higher turnover ratio means better utilization of assets and signifies improved business efficiency and profitability. The most important types of activity ratios are: * Activity Turnover Ratio * Trade Receivable Turnover Ratio + Trade Payable Turnover Ratio + Net Asset or Capital Employed Turnover Ratio + Fixed Asset Turnover Ratio, and * Working Capital Turnover Ratio = . Profitability Ratios: Profitability ratios are referred to as analysis of business profits in relation to the revenue generated from the business operations ( or funds) or assets used in the business and the ratios calculated to meet its objectives are termed as profitability ratios. The most common types of profitability ratios that are used to analyze the profitability of the business are:Lear UNE Online * Gross Profit Ratio * Operating Ratio * Operating Profit Ratio + Net Profit Ratio * Return on Investment (ROI) or Return on Capital Employed (ROCE) * Return on Net Worth (RONW) * Earnings Per Share * Book Value Per Share * Dividend Payout Ratio * Price Earning Ratio AccountingRatioFormulas Here, we will list the formulas of all the accounting ratios on the basic functional classification discussed above Liquidity Ratio Formulas Current Ratio Ee unre = Aeset a Current Liabilities Quick Asset uick Ratio oes - Current Liabilities Liquid Asset Liquid Ratio Pe eee eee a“ Current Liabilities SolvencyRatios Debt Equity Long - Term Debts Ratio Shareholders FundsLear UNE Online Debt to Capital Employed Ratio Proprietary Shareholders Funds ratio Capital Employed or Net Assets Total Asset Total Assets to Debt Ratio Long - Term Debts oe Net Profit Before Interest And Tax Re s Interest on Long - Term Debts atio Activity or TurnoverRatios pctvity, Cost of Revenue From Business Operations Turnover SSSRREEESEBGEGP S70°SSR(-SReenr eee T eRe EEEBEEEEL Ratio Average Inventory Net Credit Revenue From Business Operations Trade Average Trade Receivables Receivable ee Here, Average Credit Receivables = atio Opening Debtors and Bill Receivables + Closing Debtors and Bill 2 Net Credit Purchase Trade Average Trade Payables Payable Ratio Here, Average Credit Payables = Turnover Ratio Opening Debtors and Bill Payables + Closing Debtors and Bill: 2Lear NEOnlne Net Asset or Capital Employed Turnover Ratio Fixed Asset Turnover Ratio Working Capital Turnover Ratio Net Revenue From Business Operations Net Fixed Assets Net Revenue From Business Operations Working Capital ProfitabilityRatios Gross Profit Ratio Gross Profit Net Revenue of Business Operations meee Operating Cost of Revenue From Business Operations + Operating Expe Ratio Net Revenue From Business Operations Operating Profit «100 Revenue From Business Operations Operating Profit Ratio Here, Operating Profit = Revenue From Business Operations Operating Cost Net Profit Net Profit 100 Ratio Revenue From Business Operations Return on Investment cane Profit Before Interest And Tax Return on Oo x 100 Capital Capital Employed Employed (ROCE)Lear UNE Online Return on Net Worth (RONW) or Return on Shareholder’s Fund Earnings Per x 100 Profit Available For Equi Shareholders Share Number of Equity shares Book Value Equity Shareholders Fund Per Share Number of Equity shares Dividend Dividend Per Share Payout Ratio Earning Per Share Price Earning Ratio Market Price of Share Earning Per Share Last updated date: 19th Oct 2023 + Totalviews: 200.6k + Views today: 5.00kHi Gauri, Best courses for you Full syllabus LIVE courses Surtng Fem e.08aMen Topicspecitic course Surtng em g ON aot fo ET Vedaniti, Lear NEOnlne One-to-one LIVE classes sartng fom z.togntVedaniti, Lear NEOnlne Class 12pass Class 12. 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