formulas and ratios are used to manipulate information so that
accountants and other users of financial information can extract useful
information to determine the health of a business.
It is really quite easy to predict a company's ability to survive. A quick examination of the financial statements can yield a treasure of important information. This information will tell you if the company is collecting its revenues in a timely manner and if it has too much debt and may not be able to survive a downturn in the economy. Also, it is quite easy to determine if a company is earning enough to stay in business.
Accounting formulas and ratios are used by investors to determine
if their investment in a company is prudent. Also, financial audit
firms will use these formulas to assess the company and make
recommendations for improving the health of a company's finances.
Potential employees should also review the financial statements of a company to make a determination of whether the company will be around for a long time, and if it is profitable.
The most basic of accounting formulas is:
Ratios are used for quick analysis of financial reports. There are three main categories that ratios cover:
Liquidity ratios try to determine if a company has enough liquid assets to continue to operate:
Profitability ratios try to determine if the business is earning enough to stay in business, or if the money invested could earn more elsewhere:
What is the company's competition doing? Is the competition expanding and creating new cost effective ways to operate? Is the economic climate of the country and the world favorable or unfavorable for this company?
With a deep analysis of a company's financial statements and annual reports, etc, a good opinion can be made as to whether this is a sound company that has potential future growth opportunity or whether it is unlikely to survive a downturn in the economy.