The accounting prior sections introduced the fundamental documents used to account for company transactions and activities.

We mentioned that one of the purposes of the financial statements is to aid managers in making decisions.

Now, let’s take a look at how some of the information obtained through the accounting process is used by managers.

Company Performance

Financial and managerial accounting provide us with the information that we need to assess the performance of a company.

Generally, assessment is done by calculating performance metrics. These metrics are derived primarily from the financial statements.

Managers employ many approaches to assembling and deriving information about company performance from the information in the financial statements. Perhaps most notably, managerial accounting is heavily concerned with how costs or expenses are allocated to the activities of the organization.

We cover cost accounting in greater detail in our Accounting Course. For now, let’s take a look at some of the common, company performance ratios that managers track.

What are Profitability Ratios?

Profitability Ratios are used to determine how profitable is a given company as compared to management expectations or compared to other companies.

The most common ratios used for this comparison include:

• Gross margin ratio = Gross margin / Net sales

Indicates the gross margin generated for each dollar in net sales.

• Profit margin ratio = Net income / Net sales

Indicates the profit generated for each dollar in net sales.

• Return on assets = Net income / Average total assets

Indicates how much net income was generated from each dollar in average assets invested.

• Return on common shareholders’ equity = (Net income − Preferred dividends) /Average common shareholders’ equity.

Indicates how much net income was generated from each dollar of common shareholders’ equity.

• Earnings per share = Net income − Preferred dividends / Weighted average common shares outstanding

Indicates how much net income was earned for each share of common stock outstanding.