Understand Your Business with the Help of Accounting Ratios

Your business’s accounting department does a lot more than just calculating and paying out employee salaries. It gives out numbers that paint a very clear picture of how well the business is doing, financially.

These numbers are called business ratios.

Here’s what they mean:

Liquidity ratios

Liquidity ratios explain whether a certain company has the means to fulfil its short-term debt obligations. It talks about the number of current assets that your company owns in order to pay off the current liabilities that it owes. Any potential investor will usually look at three different types of liquidity ratios—the current ratio, cash ratio, and quick ratio.

Generally speaking, if your company has a liquidity ratio above 1, it could easily get approved for credit. This indicates that your company has enough assets to satisfy its bills. At the same time, a higher liquidity ratio isn’t always a good sign. It means that your company has too much cash tied up in inventory.

Profitability ratios

Most of your stakeholders are directly interested in knowing how well you’re doing in terms of profit generation. A healthy profit generation indicates that your company has good financial health, is doing great in terms of sales, and can pay out a decent dividend. Profitability ratios also tell you the extent to which your sales revenue exceeds the cost of goods sold.

There are three main types of profitability ratios: gross profit margin, net profit margin, and operating profit margin. Gross profit margin compares the total gross profit that your company has earned compared to the sales revenue. On the other hand, the net profit margin considers the total net profit and operating profit margin divides the operating profit by total sales amount.

Leverage ratios

These types of ratios indicate whether a company’s operations can help generate a higher rate of return than the interest rate on its debt. Too much debt can cause a significant dip in the leverage ratios. Similarly, too little debt indicates the company’s inability or reluctance to borrow.

Do you need help calculating your company’s financial ratios? Duggal Professional Corporation from Edmonton can help you. We are a full-service accounting firm that will help you stay on top of your financial ratio requirements. Our additional services include business consultancy and reporting, startup planning, bookkeeping, and payroll services. Take a look at our tax and accounting services online.