Types of Accounting Ratios, Check Complete list, definition & More

Accounting ratios are one of the most important tools used in financial analysis. Whether you are a student, a business owner, an investor, or a financial professional, understanding accounting ratios helps you interpret a company’s financial position and performance with clarity. Ratios transform raw financial data into meaningful insights, making it easier to compare results, analyse trends, and make decisions. In this article, we will discuss the complete list of accounting ratios, their types, definitions, and practical examples in a simple and easy-to-understand manner.

What is an accounting ratio?

An accounting ratio is a mathematical comparison of two financial values ​​derived from a company’s financial statements, such as the balance sheet, profit-and-loss account, or cash flow statement.

For example:

• If you divide net profit by sales, you get the net profit ratio, which tells you how much profit the company is making from its sales.
• If you divide current assets by current liabilities, you get the current ratio, which tells you how easily a company can meet its short-term obligations.

In simple terms, accounting ratios serve as indicators of profitability, efficiency, liquidity, and solvency.

Why are accounting ratios important?

Accounting ratios aren’t just boring figures on paper; they’re like a business’s health check report. They make it easy to assess how a company is performing and how it’s doing financially. Here’s why they’re so important:

Helps in performance evaluation: Ratios provide a clear picture of a company’s performance. They indicate whether profits are growing, costs are under control, and resources are utilised efficiently. In short, they highlight both strengths and problems.

Simplifies financial data: Financial statements are often filled with hundreds of figures, which can be confusing. Ratios simplify this data by turning it into easy-to-read statistics. 

Makes comparisons easier: With the help of ratios, companies can compare their performance with competitors or their own past results. This makes it easier to see whether the business is improving, lagging, or keeping pace with the industry.
Helps investors: For investors, ratios are like a guide. They tell whether a company is profitable, efficient, and worth investing in. A strong set of ratios builds confidence that the business can generate good returns.

Types of Accounting Ratios

When you look at a company’s financial statements, you’ll see a lot of figures. But figures don’t tell the whole story. So the Accounting ratios serve as shortcuts that help you understand whether a company is performing well or not.

These ratios are generally divided into five main types:

1. Liquidity Ratios
2. Profitability Ratios
3. Efficiency Ratios
4. Leverage Ratios
5. Market Ratios

1. Liquidity Ratios

Liquidity ratios measure how easily a company can pay its short-term debts (obligations due within a year). They tell us if the company has enough cash or assets that can be quickly converted into cash.

Key Ratios:

• Current Ratio = Current Assets ÷ Current Liabilities
  Shows overall ability to pay short-term debts.
  Example: If a company has ₹80,000 current assets and ₹40,000 liabilities, the current ratio = 2:1.
  
• Quick Ratio (Acid-Test Ratio) = (Current Assets – Inventory – Prepaid Expenses) ÷ Current Liabilities
  A stricter measure, as it excludes inventory which may take time to sell.
  
• Cash Ratio = (Cash + Cash Equivalents) ÷ Current Liabilities
  Shows how much debt can be paid immediately with cash in hand.
  

2. Profitability Ratios

Profitability ratios show how much profit the company is actually making. After all, the main goal of any business is to earn money. These ratios help measure that success.

Key Ratios:

• Gross Profit Ratio = (Gross Profit ÷ Net Sales) × 100
  Shows profit margin before expenses like rent, salaries, etc.
  
• Net Profit Ratio = (Net Profit ÷ Net Sales) × 100
  Final profit margin after all expenses and taxes.
  
• Return on Assets (ROA) = (Net Profit ÷ Total Assets) × 100
  Tells how efficiently assets are used to generate profit.
  
• Return on Equity (ROE) = (Net Profit ÷ Shareholders’ Equity) × 100
  Measures the return that equity shareholders are getting.
  
• Earnings Per Share (EPS) = (Net Profit – Preference Dividend) ÷ No. of Equity Shares
  Profit available for each share.
  

3. Efficiency (Activity) Ratios

Efficiency ratios (also called activity ratios) measure how well a company uses its resources. Are they selling products fast? Are customers paying bills on time? Are assets being used properly?
Key Ratios:

• Inventory Turnover Ratio = Cost of Goods Sold ÷ Average Inventory
  Shows how quickly stock is sold and replaced.
  
• Debtors (Receivables) Turnover Ratio = Net Credit Sales ÷ Average Trade Debtors
  how fast the company collects payments from customers.
  
• Creditors (Payables) Turnover Ratio = Net Credit Purchases ÷ Average Trade Creditors
  Tells how quickly the company pays its suppliers.
  
• Asset Turnover Ratio = Net Sales ÷ Average Total Assets
  Shows how efficiently assets generate sales.
  

4. Leverage (Solvency) Ratios

Leverage ratios measure a company’s long-term financial stability and how much it depends on borrowed money (debt).

Key Ratios:

• Debt-Equity Ratio = Total Debt ÷ Shareholders’ Equity
  Shows the balance between borrowed funds and owners’ funds.
  
• Interest Coverage Ratio = EBIT ÷ Interest Expense
  Tells how comfortably a company can pay interest on loans.
  
• Debt Ratio = Total Debt ÷ Total Assets
  Shows the proportion of assets financed by debt.
  

5. Market Ratios

Market ratios are used mostly by investors to analyse a company’s stock performance and market value. They connect the company’s financial results with its share price.

Key Ratios:

• Earnings Per Share (EPS) = (Net Profit – Preference Dividend) ÷ No. of Equity Shares
  Already discussed above, but important here as well.
  
• Price to Earnings Ratio (P/E Ratio) = Market Price per Share ÷ Earnings per Share
  Shows how much investors are willing to pay for each ₹1 of earnings.
  
• Dividend Yield Ratio = (Dividend per Share ÷ Market Price per Share) × 100
  Shows return to investors in the form of dividends.
  
• Market Value to Book Value Ratio (M/B Ratio) = Market Value per Share ÷ Book Value per Share.

Final Thoughts

Accounting ratios are a powerful financial tool that simplifies complex financial statements into meaningful numbers. By analysing liquidity, solvency, profitability, and efficiency ratios, one can get a complete picture of a company’s health.

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