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accounting ratiosTo those unfamiliar with the world of financial accounting, all of the math involved may be a bit overwhelming and will scare some people off. While there are, in fact, a lot of figures to work with in the accounting world, one of the interesting things about all of these intimidating figures is that they all tell a story about a company. The dollar amounts found in the major financial statements not only indicate how much money is coming into and going out of a business, but, when plugged into various ratios, they tell the story of that business’ leverage, liquidity, and profitability, among others.

If you’re interested in the world of accounting, or would just like to alleviate your fear of numbers and ratios, you’re in the right place. Today, we will discuss many of the most often used ratios in accounting, showing the ratio, as well what it says about a company. If you’d like to dig a little deeper into accounting, check out this article on the accounting concepts everyone should know, then take a look at this course on the basics of accounting.

Before we get started on these accounting ratios, it’s important to understand that there are no universally accepted, perfect ratios out there. One industry’s strong current ratio is another industry’s week current ratio. These figures will differ depending on many factors, so be aware of what is considered acceptable in a certain situation.

Liquidity Ratios

These ratios are of special interest to a company’s potential creditors, showing how well the company will be able to pay off their short term (less than 12 months) debts.

Asset Turnover Ratios

Just as the name indicates, these ratios illustrate how efficiently a company utilizes, or turns over, their assets.

Financial Leverage Ratios

An important indication of how a business uses long-term debt, the financial leverage ratios show both those on the inside as well as the outside of a company how efficiently they are using borrowed money. If they are too highly leveraged, then there is the possibility of bankruptcy, or they may have issues finding lenders in the future. However, leverage is not all bad, and can lead to tax advantages.

Profitability Ratios

The real bread and butter of a business, these ratios indicate whether or not money is being made, and how efficiently they are using their resources. They take into account the expenses, as well as other relevant costs, that the business incurs, then asses whether or not earnings are being made. Here, you want the ratios to be as high as possible, as that would indicate that there are profits being made.

If you made through this entire article, chances are you find the story that these ratios tell about a business to be fascinating. They are handy, quick ways for anyone interested to see if a business is doing well or not, and for those potential stockholders out there, this is a good way to invest wisely. If you’d like to really tackle the concepts of accounting, both the basics as well as the harder stuff, these two course on financial accounting, part one, and part two, will make experts out of the novices.

Page Last Updated: February 2020

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