Ways to Express Accounting Ratios
Accounting ratios can give financial statement users the opportunity to make quick judgments about the health of your company. While these ratios only provide a short glimpse under the hood of your company, they offer generally understood inferences. When you're speaking with creditors or potential investors and they want to know some of your company's financial ratios, you should be able to show them. Understanding the way these ratios are expressed is the first step in making sure that you look like you know what you are talking about.
Many financial ratios are expressed as a percentage of another financial figure. For example, the gross profit margin, a measure of the amount of profit earned when making sales, is calculated as sales less cost of goods sold all divided by sales. If this ratio is determined to be 0.17, it is spoken of as a 17 percent gross profit margin. Other common financial ratios that are expressed in this manner include profit margin, contribution margin ratio and variable expense ratio.
Financial ratios that do not have percentage meanings are often just expressed as a unitless decimal number. For example, the current ratio, a measure of a company's liquidity, is calculated as current assets divided by current liabilities. While this may sometimes be expressed as a ratio, such as 4.2:1, most often this will be shown only in numbers. Many of the most common liquidity and solvency ratios are expressed in this manner; they include quick ratio, debt ratio, turnover ratios, return on assets, return on equity and the price to earnings ratio.
Some financial ratios use a denominator of interest to express financial meaning. For example, a common measure of a company's ability to service debt payments is the times interest earned ratio. This figure is calculated by dividing earnings before interest, taxes, depreciation and amortization -- known as EBITDA -- by interest expense. This gives a measure of how many multiples of the company's interest expense the company earns. These types of ratios are also known as coverage ratios, as they tell financial statement users how well the company can cover a certain expense.
Financial statement ratios related to inventory, accounts payable and accounts receivable are often expressed as a time period, such as days outstanding. For example, days sales outstanding, which measures how well a company is managing accounts receivable, is calculated as average accounts receivable divided by average sales per day. This ratio is then expressed as X number of days sales outstanding. Other financial ratios expressed in number of days or a time period include days payable outstanding, inventory conversion period, cash conversion cycle and payback period.