Accounting, 3rd Edition

Chapter 9

Interpretation of accounts

‘More money has been lost reaching for yield than at the point of a gun.’

Raymond Revoe Jr, Fortune, 18 April 1994, Wiley Book of Business Quotations (1998), p. 192.

Learning Outcomes

After completing this chapter you should be able to:

• Explain the nature of accounting ratios.
• Appreciate the importance of the main accounting ratios.
• Calculate the main accounting ratios and explain their significance.
• Understand the limitations of ratio analysis.

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Chapter Summary

• Ratio analysis is a method of evaluating the financial information presented in accounts.
• Ratio analysis is performed after the bookkeeping and preparation of final accounts.
• There are six main types of ratio: profitability, efficiency, liquidity, gearing, cash flow and investment.
• Three important profitability ratios are return on capital employed (ROCE), gross profit ratio and net profit ratio.
• Four important efficiency ratios are trade receivables collection period, trade payables collection period, inventory turnover ratio and asset turnover ratio.
• Two important liquidity ratios are the current ratio and the quick ratio.
• Five important investment ratios are dividend yield, dividend cover, ...