These accounting ratios and formulas can keep your business's finances in order.

  • Keeping good records is essential to running a small business, but the bookkeeping process can be time-consuming.
  • Accounting ratios and formulas allow you to quickly evaluate your company’s financial condition.
  • You can use accounting ratios on a quarterly or annual basis, depending on the type of business you have. 
  • This article is for small business owners who want to use accounting ratios and formulas to understand their financial situation.

Having a basic understanding of accounting is essential to running a small business. Keeping up with various formulas and bookkeeping processes can be time-consuming, tedious work. But sticking with it can give you a clear picture of your company’s current financial health so you can make important decisions. 

The first step to good accounting practices is accurate recordkeeping on things like accounts receivable and accounts payable, inventory and other business transactions. If you’re looking to streamline your accounting process further, you should choose accounting software to do a lot of the hard work for you, but it’s still helpful to understand the accounting basics, including accounting ratios.

Accounting ratios offer quick ways to evaluate your company’s financial condition. According to Accounting Scholar, ratios are the most frequently used accounting formulas in regard to business analysis. Analyzing your finances with these ratios helps you identify trends and other data that guide important business decisions. 

Here are the most common types of ratios and the various formulas you can use within each category: 

  • Liquidity ratios
  • Profitability ratios
  • Leverage ratios
  • Turnover ratios
  • Market value ratios 

While it may not be possible to constantly analyze all of these ratios at a given time, it’s crucial to pick a few that are pertinent to your business’s operations so you can stay up to date on what’s happening within your company.

Did you know?FYI: You can learn all the business vocabulary you need with this basic accounting terms infographic.

What are accounting ratios?

Before we get into the different types of accounting ratios, it’s helpful to define them. Accounting ratios measure your organization’s profitability and liquidity, and can show if it’s experiencing financial problems. 

You can use these ratios on a quarterly or annual basis, depending on the type of business you run. For example, a turnover ratio is important to a brick-and-mortar retailer. Using the right accounting ratios can give a high-level overview of how your company is performing. 

Let’s look at some of the most commonly used accounting ratios so you can see which ones could be beneficial to your business. 

Liquidity ratios

These ratios are used to calculate how capable your company is of paying its debts, usually by measuring current liabilities and liquid assets. This determines how likely it is that your business will be able to pay off short-term debts. These are some common liquidity ratios: 

  • Current ratio = current assets ÷ current liabilities. The purpose of this ratio is to measure if your company can currently pay off short-term debts by liquidating your assets. 

  • Quick ratio = quick assets ÷ current liabilities. This ratio is similar to the current ratio above, except that to measure “quick” assets, you only consider your accounts receivable plus cash plus marketable securities. 

  • Net working capital ratio = (current assets – current liabilities) ÷ total assets. By calculating the net working capital ratio, you’re calculating the liquidity of your assets. An increasing net working capital ratio indicates that your business is investing more in liquid assets than fixed assets. 

  • Cash ratio = cash ÷ current liabilities. This ratio tells you how capable your business is of covering its debts using only cash. No other assets are considered in this ratio. 

  • Cash coverage ratio = (earnings before interest and taxes + depreciation) ÷ interest. The cash coverage ratio is similar to the cash ratio, but it calculates how likely it is that your business can pay interest on its debts. 

  • Operating cash flow ratio = operating cash flow ÷ current liabilities. This ratio tells you how your current liabilities are covered by cash flow.

Profitability ratios

Accountants use these ratios to measure a business’s earnings versus its expenses. These are some common profitability ratios: 

  • Return on assets = net income ÷ average total assets. The return-on-assets ratio indicates how much profit companies make compared to their assets. 

  • Return on equity = net income ÷ average stockholder equity. This ratio shows your business’s profitability from your stockholders’ investments. 


Written By Matt D'Angelo