Accountancy · Ch 9 — Accounting Ratios
Meaning of Accounting Ratios
Meaning of Accounting Ratios
A ratio is a mathematical relationship between two numbers, expressed as a fraction, a proportion, a percentage, or a number of times. When both numbers come from a business’s financial statements — the Balance Sheet and the Statement of Profit and Loss — the resulting ratio is called an accounting ratio.
For example, if Gross Profit is ₹10,000 and Revenue from Operations is ₹1,00,000, the ratio is:
10,000 / 1,00,000 = 0.10 or 10%
This is the Gross Profit Ratio. Similarly, if Inventory Turnover Ratio is 6, it means inventory converts into Revenue from Operations six times during the year.
An accounting ratio is only meaningful if the two numbers it compares are logically related. A ratio between unrelated figures — say, Furniture (₹1,00,000) and Purchases (₹3,00,000) — gives a number of 3, but that number has no useful interpretation because there is no cause-and-effect or financial link between furniture and purchases.
The reliability of any ratio depends entirely on the accuracy of the underlying financial statements. If the statements contain errors, the ratios derived from them will also be misleading. Ratios are derived numbers — they are only as good as the data they come from. …