Managerial Accounting (Ratios 2/5)

1. Ratios are simply quantitative measures that serve as indicators of the health or performance of the company or a specific product or department of the company. Some ratios are:

• Return on investment (ROI): This ration measures the profitability of a given investment compared to the cost of that specific investment. For example, if we invest total $100.000 on something that had resulted to $250.000 profit the ratio will be 2.5 (being the profit divided by the total investment) and a number of 2.5 indicates that we make 2.5 times our money back. (of course, this is an extreme example as it is not common for investments to cover and make profits within the first year and therefore it is not even expected for a ROI to be Higher than 1 the first year).

• Gross margin ration: This ration is calculated by dividing the net profit by the net sales (Revenue) and then multiply by 100. This indicates how much money the company is making per sale after the cost of sales. Gross profit refers to Sales minus any cost incurred for the sale to happen known as Cost of Goods Sold (COGS). The formula is therefore ((Revenue – COGS) / Revenue) x 100. And to put some perspective to the example let’s use some numbers. Let’s assume that a company make $120.000 in sales and 40.000 cost of goods sold. The ratios would have been ((120.000 – 40.000)/ 120.000) x 100 = 66.66. This number means that for every sale we make 66.66% we keep as profit. We want this number to be as high as possible. Investors examine this ratio to determine if a potential investment in a given company is good or not. (of course, this ratio alone would not be enough to reach to any conclusion but it is among the important ones.)

Some other common rations are (Return on Assets, Current ration & quick ration, Debt to equity ratio, inventory ration) each one of them serve a different purpose and targeting a different part of the company.