The Seven Key Ratios Used in Key Ratio Analysis

Key ratio analysis allows you to determine relationships between different accounts consisting of the financial statement. With this, you can find the ratio of the relative degree of numerical values that you have selected in the financial statement. This is used by business enterprises specifically in their accounting departments. One of the main goals as to why key ratio analysis is utilized by an organization is to review and monitor the weaknesses or the strengths of the company in a wide variety of perspectives or points of view. Nowadays, not only the business owner exploits accounting ratio analysis but also the managers, the stock market brokers, consultants, government agencies, shareholders and even potential buyers of a particular product.

To determine the present health of your business, key ratio analysis can be employed by your company. There are seven most common key ratios that are utilized here. The first one is the current ratio which measures the solvency of a firm by showing its capacity in paying up debts using current assets. To obtain this, one will need to divide the current assets by the current liabilities.

Second is quick ratio, which is also known as the acid test ratio in key financial ratios. This is a traditional measure to show the liquidity of a company. To calculate this, you will need to get the difference between the current assets and the inventory and divide the answer by the present liabilities of the firm.

Third is debt ratio which gauges the % of the total funds in the company given by the creditors. To compute, divide the total debt by the total assets. The next one is the ratio between the debt and net worth which tells you the relationship between the creditors' contributions and those that are provided by the owners. In addition to that, this is a measure that will tell you our ability in meeting the obligations of your firm to the creditors and the owners. To obtain the ratio, divide total debt by the real net worth.

Then, there is the average inventory turnover which expresses the number of times that your inventory has sold out annually. This will help you determine whether or not the inventory is being controlled correctly. Get the average turnover for your inventory by dividing cost of sold goods by the average inventory. Sixth is average collection time which provides data about the average number of days you take in collecting the accounts receivables. Before computing, get first the receivables turnover by dividing net sales by accounts receivable. Then, divide accounting days by receivables turnover. Remember that the higher the days it take for collection, the greater the chance of acquiring debt losses.

Finally, we have the total assets compared to the net sales. This key ratio analysis is a measure that gives you information about your firms ability to make sales in line with your tangible assets. In other words, this shows how skilled you are in using your resources in producing revenues from purchases. Calculate this by dividing net sales by the net total assets.

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By Sam Miller  |   Submitted On February 07, 2011