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What are accounting ratios?

Accounting ratios, also known as financial ratios or financial indicators, are quantitative relationships between different financial numbers in a company’s financial statements. They are used to assess the financial performance, liquidity, solvency, profitability, and overall health of a business. Accounting ratios provide insights into the company’s financial position and help users analyze its performance and make informed decisions.

There are various types of accounting ratios, each focusing on different aspects of financial analysis. Here are some commonly used accounting ratios:

1. Liquidity Ratios: These ratios assess a company’s ability to meet its short-term obligations and measure its liquidity. Examples include the current ratio (current assets divided by current liabilities) and the quick ratio (quick assets divided by current liabilities).

2. Solvency Ratios: Solvency ratios evaluate a company’s long-term financial stability and ability to meet its long-term obligations. Examples include the debt-to-equity ratio (total debt divided by total equity) and the interest coverage ratio (earnings before interest and taxes divided by interest expenses).

3. Profitability Ratios: Profitability ratios measure a company’s ability to generate profits in relation to its sales, assets, or equity. Examples include the gross profit margin (gross profit divided by sales), the net profit margin (net income divided by sales), and the return on assets (net income divided by total assets).

4. Efficiency Ratios: Efficiency ratios assess how effectively a company utilizes its resources and assets to generate sales and profits. Examples include the inventory turnover ratio (cost of goods sold divided by average inventory) and the accounts receivable turnover ratio (net credit sales divided by average accounts receivable).

5. Market Ratios: Market ratios focus on the market value of a company’s stock and its relationship with financial performance. Examples include the price-to-earnings ratio (market price per share divided by earnings per share) and the dividend yield ratio (dividends per share divided by market price per share).

These are just a few examples of accounting ratios, and there are many more that can provide valuable insights into a company’s financial health and performance. When interpreting accounting ratios, it is important to compare them to industry benchmarks, historical trends, and other companies in the same sector to gain a meaningful understanding of the company’s financial position and performance.