How are financial ratios useful in accounting?

Financial ratios are essential tools in accounting as they provide a quantitative analysis of a company's performance and financial condition. By comparing various financial figures, such as revenue, expenses, assets, and liabilities, these ratios enable stakeholders—such as management, investors, and analysts—to assess the company's profitability, liquidity, efficiency, and solvency.

For example, common financial ratios include the current ratio, which evaluates liquidity by comparing current assets to current liabilities, and the return on equity, which measures profitability by indicating how effectively a company uses its equity to generate profits. These insights are crucial for making informed decisions regarding investments, operations, and overall financial strategies.

In contrast, although aspects like employee salaries, depreciation calculations, and customer satisfaction metrics are important in their respective contexts, they do not directly pertain to the specific function of financial ratios in evaluating a company's financial health or performance. Thus, the role of financial ratios as indicators of a firm's financial status is paramount.