Without the accounting ratios, the financial statements of a business would be unhelpful
and vague to those who use them.
I’m Thomas Harwood and Welcome to The Accounting Student, where we create free and short videos
so that you can learn about accounting.
Today’s video is looking at the introduction to the accounting ratios.
The financial statements such as the income statement and the balance sheet would be very
uninformative to all but the highly skilled professionals, without the use of the accounting
ratios.
The accounting ratios play such an important role that they can fulfil the needs of the
users of the financial statements, whereby these statements can be easily interpreted
and be of beneficial use.
Accounting ratios are used to analyse or compare financial data, and this will allow the person
to gain an insight into how a business is performing from one period to another or how
a business is performing against another business.
Ratios can help people across business world answer many questions that they may have,
such as,
Why is one business more or less profitable than another business?
Does the business have good controls of its expenses?
What type of returns can I earn as a shareholder, if I invest in this business?
Does the business have the ability to pay its debts when they are due?
Or how well does the business manage the assets it has?
Ratio analysis can help in answering and solving all these questions.
There are normally four main stages with the ratio analysis.
Firstly you collect the financial data from the financial statements. Then you calculate
the ratios and once these have been calculated you then interpret and analyse the outcomes
from the ratios. And finally take some action based on the analysis to improve or solve
the situation for future periods.
The accounting ratios use the financial information mostly from the income statement and balance
sheet.
From the income statement, common information used will be the revenue, cost and profit
figures. And from the balance sheet, the typical information used will be the current assets
and liabilities figures including inventory, debtors and creditors.
Following on, the accounting ratios can be categorised into three main groups and they
are profitability, liquidity and efficiency.
Profitability ratios look at the profits and returns of the business. This is normally
shown as a percentage of the revenue of the business.
Liquidity ratios focus on the businesses ability to pay back the debts it has.
And the efficiency ratios look at the timescale of when the business receives payments from
its customers and when it pays its suppliers. And also how quickly does it take to turnover
its inventory within the business.
Similar to the video on "The users of accounting information" there are some groups of interest
that we can categorise who maybe interested with each of these ratio groups.
For the profitability ratios, users such as shareholders, the government, competitors
and employees maybe interested in how profitable the business is.
The shareholders, lenders and suppliers will be interested in the liquidity ratios to see
if the business has the financial capability to pay its debts and loans.
And lastly for the efficiency ratios the shareholders, lenders and competitors may be of interest
in terms of how efficient the business is within all areas of the business.
So that was the introduction to the accounting ratios. If you enjoyed it, press the like
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