*Economics
/10. Mathematics Methods in Economics
Babalola, Yisau Abiodun [PhD Student]
Accounting and Auditing Department
East Ukrainian National University [Volodymyr Dahl], Lugansk, Ukraine
If financial accounting can play an essential role in economic
development; then, high-quality corporate reporting will be the key to
improving transparency, facilitating the mobilization of domestic and international
investment, creating a sound investment environment and fostering investor
confidence. A strong and internationally comparable reporting system
facilitates international flows of financial resources while at the same time
helping to reduce corruption and mismanagement of resources. It also
strengthens international competitiveness of enterprises in attracting external
financing and taking advantage of international market opportunities. The importance of ratio analysis in accounting allows for deeper review
and comparison of a company's operations.
Accounting ratios are important tools for performing a financial analysis.
Business owners must understand a few basic accounting ratios.
The use of accounting ratios is
a time-tested method of analyzing a business. Wall Street investment firms,
bank loan officers and knowledgeable business owners all use accounting ratio
analysis to learn more about a company's current financial health as well as
its potential. Ratios analysis simplified, summarises, and systematises a long
array of accounting figures. Its main contribution lies in bringing out the
inter-relationship which exists between various segments of business. Ratios
are more of a diagnostic tool that helps to identify problem areas and opportunities
within a company. These ratios enable a company
to analyze its financial performance:
Benchmarking
Ratio
analysis allows a company to benchmark its performance against the industry
standard. Converting a company's financial statement from monetary value to
ratio results is often necessary to complete the benchmark process. Converting
monetary value to accounting ratios allow accountants to strip away the
differences inherent in financial statement reporting. Comparisons to the
industry standard are also an important aspect of ratio analysis.
A company
can prove profitability rather easily through the income statement. The balance
sheet, however, can be more difficult to break down. Ratio analysis focuses on
current assets, current liabilities and debt or equity investments made into
the business. Stakeholders often need information for analyzing the balance
sheet beyond the monetary listed on the report. Financial accounting ratios
fill this important need for analytical procedures.
Accountants often work with their
company to set goals when using financial ratios. Efficient operations are
typically able to obtain these goals. For example, a company may desire a
debt-to-equity ratio of 2.0 based on balance sheet information. Accountants
must thoroughly review, record and report information to achieve this goal.
Suggestions on altering operations to achieve such a goal are also possible
with ratio analysis.
Discover
Flaws
The accounting process is not
without flaws. It is possible to inaccurately record and report information,
leading to financial misstatements. Ratio analysis can discover these
improprieties if current computed ratios are significantly different that
previous ratios. Accountants can research these differences by reviewing the
accounts behind the ratios. This is another type of check-and-balance inherent
in the accounting process, helping protect a company's financial information.
Ratio Analysis
& Variance Analysis in Managerial Accounting
Among the most important practical applications of accounting
principles are management; the leadership and decision-making that's
responsible for how a business's finances are distributed and leveraged to
deliver profit. Managerial accounting is often concerned with two key aspects
of financial practice: ratio analysis and variance analysis. Understanding how
these modes of analysis can provide information for business decisions is
important for all business managers.
Managerial accounting is a type of accounting that applies specifically to the
decisions made by managers. Although all accounting is essentially the same,
individuals who specialize in managerial accounting have more experience with
the accounts and analysis most applicable to management decisions. By contrast,
accountants in other fields such as tax accounting may not work as frequently
with the tools that managers use in the decision-making process. In managerial
accounting, ratio analysis and variance analysis provide valuable information
about performance that helps managers allocate resources, develop growth
strategies and find investors.
In managerial accounting, ratio analysis
is the practice of figuring financial ratios that are important to business
decisions and then using them to assess performance. The specific ratios that
management finds most informative vary from business to business and industry
to industry, but ratios usually provide data about profitability, leveraging or
solvency, liquidity, the asset efficiency and the business's market value.
The profitability ratio gives
managers an idea of how well their business is performing in terms of
generating profit. Important profitability ratios include return on investment,
or how much a firm earns as a percentage of total capital investment, and
profit margin or return on sales, the amount of net income generated per sales.
Solvency
Ratio analysis tells managers and
creditors how likely a business is to be able to repay its debts. These ratios
are also called leverage ratios. Leverage ratios include the debt-to-capital
ratio, which tells managers how much of the company's capital comes from owners
and how much from creditors. Useful solvency ratios also compare the firm's
assets to liabilities (the total debt ratio) and break down its debt by long-
and short-term obligations.
Liquidity
Liquidity ratios have to do with the
firm's cash flow and whether the assets available to be easily spent are
adequate to meet immediate obligations. The most common liquidity ratios are
the current ratio; current, or short-term, assets divided by current
liabilities and the quick ratio, or current assets, minus inventory, divided by
current liabilities. The quick ratio is often more useful because
"inventory that is not easily sold will not be helpful in meeting
short-term obligations."
Asset
Efficiency and Market Value
Finally, ratio analysis may also
tell managers how effectively a business is using its assets and how the
business's stock value compares to its profitability. Asset efficiency ratios,
such as inventory turnover, tell the business how long it holds onto an asset;
in this case, inventory before it realizes a return. A business with higher
inventory turnover is usually more profitable, as the business makes money only
when inventory is purchased and then sold. Market value ratios --- such as the
price-to-earnings, or PE, ratio --- represent the difference between a
company's stock price and how much it earns.
Variance
Analysis
In addition to the information about
current performance that businesses gain from ratio analysis, decisions often
relies on some expectation about the difference between expected or budgeted
performance and the actual performance, as measured by a financial ratio.
Variance is also used by managers in costing decisions: In a costing variance
analysis, a manager considers the difference between the expected price of
goods or labor and their actual price. This helps provide information about the
sources of loss or gain, as well as helps create projections for the future.
To measure the quick ratio, divide
current assets by current liabilities. The term "current" refers to
assets that can easily convert to cash and debts that are payable in the near
future. The quick ratio measures a company's ability to pay its bills.
Return
on Assets
The return on assets ratio compares
profit levels to the investment in company assets. To calculate the return on
assets ratio, divide the net profit by net assets.
Borrowing
Ratio
A business's borrowing ratio is the
ratio of borrowing to the business's net worth. Calculate it by dividing
borrowings by the net worth of the business. A lender prefers to see a
borrowing ratio of at least 1:1.
Conclusion
An accountant cannot simply prepare reports that
are too confusing for others. The ability to disclose and discuss information
helps all users understand this often-technical data. An accountant can help a company
keep score in terms of monetary worthy; stakeholders may desire further
analysis on these numbers. Financial accounting ratios allow stakeholders to
determine how well a company operates in specific segments.
REFERENCES
[1] Business Accounting and Bookkeeping : http://wiki.answers.com/Q&A
[2] How Do Accountants Use
Math? | eHow.com http://www.ehow.com/how-does_4913284_accountants-use-math.html#ixzz2MrihVtI3
[3] The Role
of Mathematics in Business Decisions-By Stephen
F Keating – 1973
[4]
Greg Mostyn, Mission College: math
in accounting? Not as much as you think Worthy & James publishing.