Remembering Important Ratios for Bookkeeping - dummies

By Jane E. Kelly

Part of Bookkeeping & Accounting All-in-One For Dummies Cheat Sheet (UK Edition)

For bookkeeping purposes, there may come a time when you need to see how a company is doing. If you need to check the financial health of a company, you can analyse the accounts by using some or all of the following ratios.

  • Net profit ratio: This indicates how much profit was earned for every £100 of sales revenue. The equation is as follows:

    • Net profit ÷ Sales revenue = Net profit ratio

    For example, a business earns £1.9 million net profit and has sales revenue of £52 million. The net profit ratio is 1.9 million divided by 52 million, which is £3.65 net profit for each £100 net profit.

  • Return on equity: Tells you how much profit a business earned in comparison to the book value of the shareholder’s equity. Here’s the maths:

    • Net profit ÷ Owners’ equity = Return on equity

    If the net profit is £1.9 million and the owners’ equity is £15.9 million then the return on equity is 0.119 (£1.9 million ÷ £15.9 million), or 11.9 per cent expressed as a percentage.

  • Current ratio: This ratio is a rough indicator as to whether the business has enough cash in hand (including the cash to be converted from stock and debtors) to pay off the liabilities within the next year. Here’s the equation:

    • Current assets ÷ Current liabilities = Current ratio

    Businesses are expected to maintain a ratio of 2:1, meaning they have twice as many assets as liabilities. As an example, if the business has £17.2 million in current assets and £7.9 million in current liabilities, the ratio would be £17.2 million divided by £7.9 million, which equals 2.2. The business wouldn’t need to worry because the financial position is fine.