ACCOUNTING ROTIOS

Accounting ratios

•
Current ratio:

The current ratio measures a company,s ability to pay its current liability , this ratio computed as follows :

Current ratio= Total Current Assets
Total Current liability

A company prefers to have a high current ratio because that means it has plenty of current assets to pay current liability . An increasing in current ratio indicates improvement in ability to pay current debts . A decreasing in current ratio signals determination in the company’s ability to pay current liability.

A RULE OF THUMB: A strong current ratio is ( 1.50), which indicate that a company has $1.50 in current assets for every $1.00 in current liability . A current ratio of 1.00 is considered low and somewhat risky .

 

•
Debt Ratio :

 

A second decision aid the debt ratio , measures over all ability to pay debts. And it computed as follows:

Debt ratio = Total liability
Total assets

 

The debt ratio indicates the proportion of a company’s assets that are financed with debt . a low debt ratio is safer than a high debt ratio , why? Because a company with low liabilities has low required payments . This company is unlikely to get into financial difficulty.

A RULE OF THUMB: A debt ratio below 0.60 , or 60%, is considered safe for most businesses . A debt ratio above .80 ,or80% , borders on high risk.

 

 

[
b]T[/b]ow Ratios for Decision Making

•
The Gross profit percentage

Gross profit (gross margin) is net sales minus cost of good sold .
Merchandisers strive to increase the gross profit percentage , which is computed as follows :

Gross profit percentage= Goss profit
Net sales

•
The Rate of Inventory Turnover

Owners and managers strive to sell inventory quickly because the inventory generates no profit until its sold. The faster the sales , the higher the income . Inventory turnover measures how inventory is sold. Its computed as follows:

Inventory turnover = Cost of goods sold
Average Inventory

:
Notes
*

Average inventory may be taken from more than one balance of
the inventory during the period

A high turnover rate is desirable , and an increase in the turnover
rate usually means higher profits
.

Example : calculate the rate of inventory turnover , if the values are
as follows:( amounts in millions)

* beginning inventory $ 4,531
* ending inventory 5,384
* 31,445 COGS

Answer:

INVENTORY TURNOVER = 31,445 /5,384+4,531 = 6,3 time per year