Sunday October 2, 2011 12:53

# Are your company’s ratios healthy?

Posted by Steve Drago as Ratios

A few financial ratios can tell you how healthy your business is each month. Track these ratios consistently and you can spot problems brewing and take appropriate actions to improve your business. Lenders love to calculate ratios for your business. This allows them to compare your business to similar businesses to assess risks. You need to know what these ratios mean and how to improve them.

Financial ratios are relationships determined from a company’s financial information and are used for comparison purposes.  These account balances are found on one of the company’s financial statements such as the balance sheet, income statement, cashflow statement, and/or statement of changes in owner’s equity.

Current Ratio:

The Current Ratio is a liquidity ratio that measures a company’s ability to pay short-term and long-term obligations. This ratio measures whether your business has enough resources to pay its bills (invoices) over the short term. Generally the higher the ratio, the better.  Bankers will rely on this ratio when evaluating your company for a loan.

The formula is:  Current Ratio = Current Assets/Current Liabilities

Total Debt Ratio:

The Total Debt Ratio is a financial ratio that indicates the percentage of a company’s assets that are provided via debt. . This measures your business’s long-term solvency.

The formula is:  Total Debt Ratio = Total Debt/Total Assets

Profit Margin:

This measures profit as a percentage of revenue (sales).  You should try to constantly improve this percentage over time. If the percentage decreases, investigate this for corrective action.

The formula is:  Profit Margin = Net Income/Revenue

A  sampling of ratios include:

#### 1.  Short Term Solvency or Liquidity Ratios

Current ratio = Current assets / Current liabilities

Quick ratio = (Current assets – inventory) / Current liabilities

Cash ratio = Cash / Current liabilities

Net Working Capital = Net working capital / Total assets

#### 2. Long Term Solvency or Financial Leverage Ratios

Total debt ratio = (Total assets – total equity) / Total assets

Debt to Equity ratio = Total debt / Total equity

Equity Multiplier = Total assets / Total equity

Long Term Debt ratio = Long Term Debt / (Long Term Debt + Total Equity)

Times interest earned = Earnings before Interest & Taxes / Interest

Cash coverage ratio = (Earnings before Interest & Taxes + Depreciation) / Interest

#### 3. Asset Use or Turnover Ratios

Inventory turnover = Cost of goods sold / Inventory

Days’ sales in Inventory = 365 days / Inventory turnover

Receivables turnover = Sales / Accounts receivable

Days’ sales in receivables = 365 days / Receivables turnover

Net Working Capital (NWC) turnover = Sales / Net Working Capital

Fixed asset turnover = Sales / Net fixed assets

Total asset turnover = Sales / Total assets

#### 4. Profitability Ratios

Profit Margin = Net income / Sales

Return on Assets (ROA) = Net income / Total assets

Return on Equity (ROE) = Net income / Total equity