Accounting IV: Working with Ratios

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The accounting ratio compares two or more financial data used for the analysis of companies ' financial statements. This is an important method used by shareholders, investors and stakeholders of all kinds to consider companies' performance, power and financial position.

Often known as financial ratios, the efficiency and essential business decisions of the businesses can be tracked.

The following accounting ratio is covered in this article, which is classified as follows:

  • Liquidity Ratio
  • Profitability Ratio
  • Leverage Ratio
  • Activity Ratio

All of these ratios are used to monitor the performance of business and to compare the business results with competition.

Let's talk about each ratio in detail below-

  • Liquidity Ratio

    The liquidity ratio helps to calculate a company's capital adequacy in order to pay off its short-term obligations. A high liquidity ratio means that the company can pay its debtors well. The liquidity ratio affects both the company's reputation and its credit rating. If short-term debt is continually defaulted, it will lead to bankruptcy. That's why this ratio is critical for any business and credit ratings to be financially stable. This ratio indicates how fast a company can translate its existing assets into cash to reimburse its responsibilities on time. Liquidity is commonly used along with short-term solvency.

  • Profitability Ratio

    The profitability ratio is used to determine how well the company generates profits. Profit is the amount of income earned after all associated expenditures have been deducted. In relation to expenditures and costs associated with sales cycles, the productivity ratio is used to measure the company's ability to produce profit over a given time period. That ratio reflects the company's final result.

  • Leverage Ratio

    Leverage ratio measures the company's utilisation of borrowed money. It helps determine the firm's financial stability by evaluating the company's overall debt. This ratio concentrates on the company's long-term solvency in terms of the amount of capital owed by the company or the capacity to meet its financial obligations in the long term.

  • Activity Ratios

    Activity ratios measure the efficiency of the company. This is often referred to as an asset management ratio, which means how effectively management uses the assets of the business to achieve full revenues. In general, this ratio shows the sales in accordance with specific asset groups.

Why look at small business financial ratios?

Numbers are the language of business they tell a story. Although these formulas seem like a meaningless numbers to some, the results are indicators for the health of your company.

Running a good business means learning from mistakes in the past and making positive future decisions. You cannot prepare for the future of your business without a clear understanding of accounting.

You will make informed decisions about your future and set up your company for success in taking the time to examine and appreciate the financial health of your enterprise. As an indicator of whether it is the time to take the new loan, for example, total debt ratio may be a key indicator. The value of your assets in terms of your output indicates how important your assets are. This informs you about how you are improving business efficiency or investing in new assets.

You need to have a clear picture of where you are at any time to run a successful company as well as making decisions to improve.

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