Terminology Used in Ratio Analysis

Let me clarify some of the terminology used in my previous posting regarding Common Accounting Ratios.

Assets – Things owned by the entity (i.e. fixed assets, cash, CD’s, etc.)

Current Assets (CA) – Assets owned by the entity which are available within the next period’s accounting cycle (typically one year). For example, current assets would include prepaid insurance policies, cash, CD’s maturing within 1 year, inventories, accounts receivable (unless the receivable is not expected to be collectible within the accounting cycle). Fixed assets, are not current assets because they are not available to pay the debts of the organization within the accounting cycle (the assets are used in operations and are not necessarily available for liquidation to pay liabilities).  On a classified balance sheet, current assets are usually subtotaled to aid in the readability and overall usefulness of the financial statements.

Liabilities – Essentially, liabilities are the debts owed by the Company. Some liabilities are hard/concrete liabilities such debt payments or accounts payable for purchases received. Other items are estimates such as payroll and taxes for services performed but not yet paid.

Current Liabilities (CL) – Liabilities expected to be due within the next year. Please note that this is not the liabilities expected to be paid within the next year. A liability may be due but not paid within the next year; it should still be included as a current liability because the obligation is due in the current period.

Cost of Goods Sold or Cost of Sales (COGS or COS) – The cost of inventory sales or the costs directly associated with the products being sold. This item is important to understanding the overall gross margin of sales.

Gross Margin (GM) – Gross margin is the ratio of profit earned per sale. This is different from the profit margin ratio because this excludes items not directly related to the sales (i.e. excludes selling and administrative costs which are not directly related to the sales). For example cost of goods sold would include the inventory expense (cost of purchasing or producing) the products sold but would not include the salesman’s salary due to the salesman being necessary to the overall operation of the Company and not that specific sale.

Profit Margin (PM) – This ratio is a measure of a company’s  overall profitability per each item sold and includes selling and administrative costs in addition to the costs of goods sold.