Calculating Ratios

Accounting regularly requires us to compare values. Ratios are used to compare the amount of one number to another number.

Ratios can be expressed as;

  • 1 to 5
  • 1 : 5
  • $\frac15 $ or 1 / 5

No matter which notation is used for this ratio, it is read as "1 to 5".

You will have probably encountered ratios in your everyday life. Some potential examples include;

  • The ratio of girls to boys in a class is 4 : 3
  • A pancake recipe requires a flour to milk ratio of 3 : 2
  • A model aeroplane has a scale of 1 : 48

Ratios should be expressed in their simplest form. For example, a ratio of 25 to 5 can be simplified by dividing both numbers by 5. This gives

  • $ \frac{25}{5}=\frac51 $ or 25 / 5 = 5 / 1

In accounting, we can use financial ratios as indicators of the financial position of one company in comparison to another. Accounting ratios are usually expressed with the second number in the ratio as 1, and so only the first number is written. For example, the ratio 3:1 would be written as 3. The current ratio for example, focuses on the liquidity (ability to turn assets into cash to pay liabilities) of a company. The current ratio is expressed as a decimal, for example, ABC Company has a current ratio of 1.3 or 0.9. You will be learning more about current ratios throughout your degree.

As an example, if a company has assets of \$6 million and liabilities of \$2 million, the current ratio would be calculated as follows;
$$ \newcommand{\ctext}[1]{\style{font-family:Arial}{\text{#1}}} \begin{align*}\ctext{Current ratio} &= \frac{\ctext{Current Assets}}{\ctext{Current Liabilities}} \cr
                    &= \frac{6,000,000}{2,000,000} \cr
                    &= \frac31 \cr
                    &= 3 \end{align*} $$
In other words, for every three dollars in assets, the company has one dollar in liabilities.

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