How to Review Financial Accounting Ratios

Introduction

Accounting ratios are statistical formulas that companies use to assess financial performance. Companies often compute ratios at month end, when new statements are available from the company. Different ratios exist to assess individual pieces of a company’s financial performance. Knowing the ratio and its use allows an individual to analyze the accounting ratio. Ratio analysis is also a benchmark tool for assessing performance to previous periods or the industry standard. Most companies use universal accounting ratios, making analysis a fundamental business practice.

Analysis Steps

Review prepared ratios. Separate the results into specific groups, such as profitability, asset turnover and financial leverage ratios. The information in each ratio formula will help determine what group it belongs.

Look at the ratio result. Compare it to a previous period or the industry standard. For example, a current ratio of 1.2 in June is comparable to the current ratio of 1.4 in May.

Determine if the ratio is better or worse than the previous period. For example, the previous current ratio indicates the company is worse off at paying short-term financial obligations. High ratio results over 1.0 are preferable for the current ratio.

Complete the same ratio analysis each month. Use the same information and formula in order to create a benchmark trend. This allows for a complete ratio analysis for the company’s financial statements.

Reminders
Each ratio has a different purpose. In some cases, the result should be high and in other cases lower in order to assess the business’ operations. Essentially, not all ratios will have the same meaning.

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