Accounting is generally considered to be the process of keeping track of a businesses' finances by keeping track of its accounts payable, accounts receivable and other financial transactions – often with accounting software.
However, those looking to better understand the nuances of accounting need to understand the concept of accounting formulas.
Accountants use equations and formulas to calculate the financial condition of a business.
Among those formulas are accounting ratios, which, according to Accounting Scholars, are among the most popular and widely used tools of financial analysis and can help uncover conditions and trends that are difficult to find by inspecting individual components that make up the ratio.
Ratios are mathematical relationships between two quantities expressed as a percentage, rate or proportion.
Accounting ratios are divided into five main categories, including liquidity ratios, profitability ratios, leverage ratios, turnover ratios and market value ratios.
Each category includes various formulas to assist accountants in their analysis of a company's financial condition and accounting software often helps you to find the information needed to do these equations.
The ratios include:
- Current Ratio = Current Assets/Current Liabilities
- Quick Ratio = Quick Assets/Current Liabilities
- Net Working Capital Ratio = Net Working Capital/ Total Assets
- Cash Ratio = Cash/Current Liabilities
- Return on Assets = Net Income/Average Total Assets
- Return on Equity = Net Income/Average Stockholder Equity
- Profit Margin = Net Income/Sales
- Earning Per Share = Net Income/Number of Common Shares Outstanding
- Price-to-Earnings Ratio = Price Per Share/Earnings Per Share
- Market-to-Book Ratio = Market Value Per Share/Book Value Per Share
- Inventory Turnover Ratio = Costs of Goods Sold/Average Inventories
- Assets Turnover Ratio = Sales/Average Total Assets
- Accounts Receivable Turnover Ratio = Sales/ Average Accounts Receivable
- Debt to Equity Ratio = Total Debt/Total Equity
- Total Debt Ratio = (Total Assets – Total Equity)/Total Assets
- Long Term Debt Ratio = Long Term Debt/9Long Term Debt + Total Equity)
- Cash Coverage Ratio = (Earnings Before Interest and Taxes + Depreciation)/Interest
An example of an accounting ratio's usefulness, provided by Accounting Scholars, is the fact that determining how much cash a company has versus how much short-term debt it has coming is substantially more beneficial than simply knowing how much cash the business has in the bank.