Accounting Ratios
Accounting ratios are relationships expressed in mathematical terms between the figures which are connected with each other in some manner. Obviously, no purpose is served by comparing two sets of figures which are not at all connected with each other. Moreover, absolute figures are also unfit for comparison.
The following are the different classification of ratios:
1. Traditional classification: The traditional classification has been on the basis of the financial statement to which the determinants of a ratio belong. On this basis the ratios may be classified as follows:
a) Profit and loss account ratios: The ratios are calculated on the basis of the items of the profit and loss account only e.g. gross profit ratio, stock turnover ratio etc.,
b) Balance sheet ratios: i.e. ratios calculated on the basis of the figures of balance sheet only; e.g. current ratio, debt-equity ratio etc.,
c) Composite ratios or inter-statement ratios: i.e. ratios calculated on the basis of figures of profit and loss account as well as the balance sheet; e.g. fixed assets turnover ratio, overall profitability ratio etc.
d) Functional classification: The traditional classification has been found to be too crude and unsuitable because analysis of balance sheet and income statement cannot be done in isolation. They have to be studied together in order to determine the profitability and solvency of the business. In order that ratios serve as a tool for financial analysis, they are now classified on the basis of their function or purpose as detailed below:
Profitability ratios, turnover ratios and financial ratios.
Profitability ratio: Profitability is an indication of the efficiency with which the operations of the business are carried on. Poor operational performance may indicate poor sales and hence poor profits. A lower profitability may arise due to the lack of control over the expenses. Bankers, financial institutions and other
The following are the different classification of ratios:
1. Traditional classification: The traditional classification has been on the basis of the financial statement to which the determinants of a ratio belong. On this basis the ratios may be classified as follows:
a) Profit and loss account ratios: The ratios are calculated on the basis of the items of the profit and loss account only e.g. gross profit ratio, stock turnover ratio etc.,
b) Balance sheet ratios: i.e. ratios calculated on the basis of the figures of balance sheet only; e.g. current ratio, debt-equity ratio etc.,
c) Composite ratios or inter-statement ratios: i.e. ratios calculated on the basis of figures of profit and loss account as well as the balance sheet; e.g. fixed assets turnover ratio, overall profitability ratio etc.
d) Functional classification: The traditional classification has been found to be too crude and unsuitable because analysis of balance sheet and income statement cannot be done in isolation. They have to be studied together in order to determine the profitability and solvency of the business. In order that ratios serve as a tool for financial analysis, they are now classified on the basis of their function or purpose as detailed below:
Profitability ratios, turnover ratios and financial ratios.
Profitability ratio: Profitability is an indication of the efficiency with which the operations of the business are carried on. Poor operational performance may indicate poor sales and hence poor profits. A lower profitability may arise due to the lack of control over the expenses. Bankers, financial institutions and other