Accounting Ratio Definition

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What is an accounting ratio?

Accounting ratios, a significant subset of financial ratios, are a group of parameters used to measure the efficiency and profitability of a business based on its financial reports. They make it possible to express the relationship between an accounting data point and another and constitute the basis for the analysis of the ratios.

What do the accounting ratios tell you?

An accounting ratio compares two items in a company’s financial statements, namely its income statement, its balance sheet and its cash flow statement. These ratios can be used to assess the fundamentals of a business and to provide information on the performance of the business in the last quarter or year.

Here are some examples of financial ratios:

  • Gross margin
  • Operating margin
  • Debt-to-equity ratio
  • Quick Ratio
  • Distribution ratio

Each of these ratios requires the most recent data to be relevant.

Key points to remember

  • Accounting ratios, a significant subset of financial ratios, are a group of parameters used to measure the efficiency and profitability of a business based on its financial reports.
  • An accounting ratio compares two items in a company’s financial statements, namely its income statement, its balance sheet and its cash flow statement.
  • These ratios can be used to assess the fundamentals of a business and to provide information on the performance of the business in the last quarter or year.

Examples of accounting ratios

Gross margin and operating margin

The income statement contains information on the company’s sales, expenses and net income. It also gives an overview of earnings per share and the number of shares in circulation used to calculate it. These are some of the most used data points by analysts to assess the profitability of a business.

Gross profit as a percentage of sales is called gross margin. It is calculated by dividing gross profit by sales. For example, if gross profit is $ 80,000 and sales are $ 100,000, gross profit margin is 80%. Operating profit as a percentage of sales is called operating profit margin. It is calculated by dividing operating profit by sales. For example, if operating profit is $ 60,000 and sales are $ 100,000, the operating profit margin is 60%.

Debt-to-equity ratio

The balance sheet provides accountants with an overview of a company’s capital structure, one of the most important measures of which is the debt-to-equity (D / E) ratio. It is calculated by dividing the debt by equity. For example, if a business has debt of $ 100,000 and equity of $ 50,000, the debt-to-equity ratio is 2 to 1.

Quick report

The rapid ratio, also known as the acidity test, is an indicator of a business’s short-term liquidity and measures a business’s ability to meet its short-term obligations with its most liquid assets. Because we are only concerned with the most liquid assets, the ratio excludes stocks of current assets.

Dividend payout ratio

The cash flow table provides data on the cash ratios. For example, the payout ratio is the percentage of net income paid to investors. Dividends and share buybacks are considered cash expenses and are shown in the cash flow table. For example, if the dividends are $ 100,000, the share repurchases are $ 100,000 and the income is $ 400,000, the payout ratio is calculated by dividing $ 200,000 by $ 400,000, which equals 50 %.

Learn more about accounting ratios

Accounting ratios are important tools in financial analysis. For a deeper understanding of why and how they are used, and for examples of many other accounting ratios commonly used by investors and analysts, please read our tutorial on the topic of financial ratios.

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