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Financial Ratios in Accounting
Made popular by Benjamin Graham, the financial ratios in Accounting are very important for a business to know its profitability and obligations for the financial year that passed. There are numerous financial ratios being used for different purposes like Gross Profit Ratio, Liquidity Ratio, etc. These ratios no doubly serve businesses with accurate valuation, but the calculation part can be tricky. A businessman typically uses the following ratios.
- Gross Profit Ratio: As the name suggests, this ratio states the profitability of a business before considering the amount of tax. To calculate this ratio, a business’ gross profit is divided by its net sales for the stipulated period, multiplied by 100 to arrive at a conclusion in terms of percentage. In accounting, this ratio is also known as the GP ratio.
- Net Profit Ratio: Where the GP ratio suggests the profitability of a business before taxes, NP Ratio or Net Profit Ratio states net profitability of a business after deducting all the applicable taxes. The calculation of this ratio is slightly different from the GP ratio, as for numerator net profit after taxes and operating expenses is taken for the calculative purpose.
- Current Ratio: Current Ratio or Working Capital Ratio is helpful in knowing liquidity of a business. To calculate this ratio, current assets of a business is divided by its current liabilities. This ratio also states the ability of a company to meet its short term and long term obligations.
- Debtors Aging Ratio: Debtors Ageing Ratio helps in knowing the number of days that takes a business to collect its debts, thus it’s also known as Debtors Days Ratio. To calculate this activity ratio total trade receivables is divided by the total amount of credit sales, multiplied by 365 (days.)
- Liquid Ratio: Liquid ratio states the liquidity of a business or in other words, it shows how efficiently a business can pay its short term and long term liabilities. Current Ratio and Quick or Cash Ratio are the two liquid ratios.
Ratio Calculation in Xero: To make these calculations simpler, Xero accounting software provides a unique feature of calculating all the required ratios under its ‘Custom Reports’ tab. It lets the users analyze their businesses and compare the same to get a sound understanding of their position through ratio calculations.
To know more about financial ratios in accounting contact Meru Accounting today!