Financial Statement Analysis - Types of Key Accounting Ratios
There are several different key accounting ratios and they are categorized according to the financial characteristic they measure. These are:
• Solvency
• Profitability
• Performance
• Investment
This Accounting Terminology Checklist outlines the terminology, concepts and conventions that are accepted within the accounting profession.
Solvency
An organization is considered to be solvent when it can pay its debts as they fall due. In day-to-day terms, this means that an organization has enough working capital to pay its suppliers.
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Profitability
These ratios measure the organization's use of its assets and control of its expenses to generate an acceptable rate of return. You can see if an organization is profitable simply by looking at an income statement, but you need to put that profit into perspective.
To do this you need to ask yourself:
• Is the profit growing in proportion to the size of the organization?
• Is the organization making as much profit on new sales as on existing sales?
• Is the organization as profitable as others in the same sector?
Performance
Is the organization making the sort of profit that it has in the past or that others in the same sector are making? By looking at individual parts of the organization you can gain more insight into their profitability and efficiency.
Investment
These ratios measure investor response to owning an organization's stock and also the cost of issuing stock. They are concerned with the return on investment for shareholders, and with the relationship between return and the value of an investment in an organization's shares.
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Remember that with most of these measures, the trend over time is often more revealing than one figure in isolation, and that comparisons between industries may not be very useful.
You may also be interested in:
Financial Statement Analysis | Key Accounting Ratios | Current Ratio Analysis | Calculating Profit | Business Performance Ratios | Price/Earnings Ratios | Price-to-Book Ratio | PEG (Price/Earnings to Growth) Ratio | Dividend Yield.
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