# Understanding Financial Ratios

Does anybody know or have a quick method to know the affect of an increase or decrease in either the numerator or denominator on a financial ratio?

I usually will use a made up example to calcuate it but i’m looking for a quicker way to know…

Very basic example : The current assets are \$6 mm and the current liabilities are \$4 mm. What is the effect on the Current Ratio if current assets rises to \$8 mm?

My train of thought – CA/CL = CR … 6/4 = 1.5 with the increase … 8/4 = 2

So the CR is higher…

Can anyone help, i notice that ALOT of financial reporting questions deal with this… and not in that simple of an example??

I’m not sure if I understood you correctly, but in a question like above just do the math as you did. If the question is asked without concrete numbers just set up an numerical example yourself. (I define the denominator always as 100 and than according to the question the numerator higher or lower than 100).

If you practice enough you’ll be able to do the implicit relationships completely in your head. This will safe you time in the exam.

Regards, Oscar

Yeah, Oscar is right, arithmethics is the only way, just know well the formula and play with numbers. With practice and experience you will be able to do it mentally.

Alright thank you for the insight

Oscar FTW

There is another way beside arithmetics to understand ratios. Simply as accountants perceive…

Q. The current assets are \$6 mm and the current liabilities are \$4 mm. What is the effect on the Current Ratio if current assets rises to \$8 mm?

You ( or your company) owe 4\$ and your current assets (f.ex. payroll) is 6 . If you get more 2 (ex. payroll increase) now you have 8 . After settlement all your CL you left with 4 net (2 more than before), so your liquidity ratio (CA/CL) is higher than before (assuming liablities remained equal, 4 in this example).