Ritik Kumar · September 11, 2025 
Introduction
Understanding accounting ratios is crucial for anyone delving into the world of finance, whether you’re a student, a budding entrepreneur, or a seasoned professional. These ratios provide insights into a company’s financial health, helping stakeholders make informed decisions.
In this comprehensive guide, we’ll explore the most important accounting ratios, their calculations, and practical examples. Moreover, we’ll also highlight their relevance in exams and careers so you can apply them effectively.
Table of Contents
Key Accounting Ratios Explained with Examples
1. Current Ratio – A Measure of Liquidity
The current ratio is a liquidity ratio that measures a company’s ability to pay short-term obligations.
Formula:Current Ratio=Current AssetsCurrent Liabilities\text{Current Ratio} = \frac{\text{Current Assets}}{\text{Current Liabilities}}Current Ratio=Current LiabilitiesCurrent Assets
Example:Suppose a company has current assets of ₹5 lakh and current liabilities of ₹2 lakh:
Current Ratio = Current Assets / Current Liabilities = 5,00,000 / 2,00,000 = 2.5
A ratio above 1 indicates that the company can comfortably cover its short-term liabilities, which is a good sign of financial health.
2. Debt-to-Equity Ratio – A Test of Solvency
This ratio compares a company’s total liabilities to its shareholder equity. It shows whether the company relies more on debt or equity financing.
Formula:Debt-to-Equity Ratio = Total Liabilities / Shareholder Equity
Example:If total liabilities = ₹8 lakh and shareholder equity = ₹4 lakh:
Debt-to-Equity Ratio = 8,00,000 / 4,00,000 = 2
A high ratio means heavy dependence on debt, which increases risk during financial instability.
3. Profit Margin Ratio – Profitability Check
The profit margin ratio, or net profit margin, measures how much of every rupee earned remains as profit.
Formula:Profit Margin Ratio=Net ProfitRevenue×100
Example:If net profit = ₹2 lakh and revenue = ₹10 lakh:
Profit Margin Ratio=2,00,00010,00,000×100=20%
A higher profit margin shows strong financial performance and cost efficiency.
4. Return on Equity (ROE) – Shareholder Value Indicator
ROE measures how effectively a company uses shareholder investments to generate profits.
Formula:ROE=Net IncomeShareholder Equity×100
Example:If net income = ₹3 lakh and equity = ₹15 lakh:
ROE=3,00,00015,00,000×100=20%
A high ROE reflects efficient use of shareholder funds.
5. Inventory Turnover Ratio – Efficiency in Operations
This ratio shows how many times a company sells and replaces its inventory during a given period.
Formula:Inventory Turnover Ratio=COGSAverage Inventory
Example:If COGS = ₹6 lakh and average inventory = ₹1.5 lakh:
Inventory Turnover Ratio=6,00,0001,50,000=4
A higher ratio indicates efficient inventory management, while a very low ratio signals overstocking or slow sales.
Summary Table of Ratios
| Ratio | Formula | Purpose | Ideal Benchmark |
|---|---|---|---|
| Current Ratio | Current Assets ÷ Current Liabilities | Liquidity | 1.5 – 3 |
| Debt-to-Equity Ratio | Total Liabilities ÷ Shareholder Equity | Solvency & financial risk | < 2 (industry-wise) |
| Profit Margin Ratio | (Net Profit ÷ Revenue) × 100 | Profitability | Higher is better |
| Return on Equity (ROE) | (Net Income ÷ Shareholder Equity) × 100 | Shareholder returns | 15–20% is strong |
| Inventory Turnover | COGS ÷ Average Inventory | Inventory efficiency | 4–6 times (varies) |
Exam Relevance – CBSE Class 12 Accountancy
Accounting ratios are a core topic in Class 12 Accountancy. Typically:
- 3–4 mark questions test direct formula/application.
- 6–8 mark questions involve case studies or interpretation.
- Ratios like Current Ratio, Debt-to-Equity, and Profitability Ratios are most frequently asked.
Tip: Always write the formula first, then solve numerically, and finally interpret the result in simple words.
Frequently Asked Questions
Q1. What is the ideal current ratio for a company?
A ratio between 1.5 and 3 is generally considered healthy.
Q2. Why is a high debt-to-equity ratio risky?
Because it means heavy reliance on debt, leading to high interest costs.
Q3. Why is profit margin important for investors?
It shows how efficiently a company converts sales into actual profit.
Q4. What does a low ROE indicate?
That the company is not effectively using shareholder equity to generate returns.
Q5. How can companies improve inventory turnover?
By reducing overstocking, improving demand forecasts, and enhancing supply chains.
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Conclusion
Grasping the essentials of accounting ratios is pivotal for anyone involved in financial decision-making. These ratios not only provide insights into a company’s financial health but also sharpen your analytical skills for exams and real-world applications.
Whether you’re a Class 12 commerce student preparing for CBSE exams or a professional aiming to boost your financial literacy, mastering these ratios is a valuable step.
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