Financial Ratios
Financial Ratios
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3 March 2008
Financial Ratios: Week 9 Written Assignment
Three financial ratios used in accounting are liquidity, profitability, and leverage. Financial ratios are important to accounting because it is "a tool that helps measure a business' liquidity, profitability, and reliance on debit financing, as well as the effectiveness of management's resource utilization," (Boone & Kurtz p.527).
Liquidity means having enough money on hand to meet financial obligations without having to sell fixed assets. An accountant uses the liquidity ratio as a way to "measure and show a business' ability to meet short-term obligations when they must be paid," (p.528). Current and acid test are two commonly used liquidity ratios. Current ratio "compares current assets and liabilities, giving manager's information about the business' ability to pay off its current debts as they mature," (p. 528). Basically the current ratio compares all current assets and liabilities. To find current ratio you must take current assets divided by current liabilities. Acid test ratio "measures the ability of a business to meet its debt payments on short notice, comparing quick assets against current liabilities," (p.528). Cash and equivalents, short term investments, and accounts receivable is generally what the quick assets consist of. To find acid-test ratio you must take current assets (less inventory) divided by current liabilities.
Next profitability means beneficial or useful. Therefore profitability ratios "measure a business' overall financial performance by evaluating its ability to generate revenues in excess of operating costs and other expenses," (p. 529). There are four profitability ratios gross profit margin, net profit margin, return on assets, and return on equity.
To find each of...
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