Financial Ratios

Let’s take a look at how some key ratios are calculated, and what each ratio can tell you about your business.

Solvency Ratios

Current Ratio — Current Assets divided by Current Liabilities. This indicates liquid assets available to cover current debt.
Quick Ratio — Cash plus Accounts Receivable, divided by Current Liabilities. This is a more stringent version of the Current Ratio.

Operational Efficiency Ratios

Days Sales in Inventory — Average Inventory divided by Cost of Goods Sold, times 365. Indicates the number of days that can be handled with existing inventory.

Inventory Turnover — Sales divided by Inventory. Higher ratio indicates lower carrying costs.

Accounts Receivable Turnover — Sales divided by Accounts Receivable. In general the higher the turnover ratio the better.

Average Sales Days Outstanding — 365 divided by Accounts Receivable Turnover.

Leverage Ratios

Equity Ratio — Net Income divided by Owner’s Equity. The higher the ratio, the more willing investors would be to invest in the company.

Debt Ratio — Total Debt divided by Total Assets. In general, the less the company relies on debt for asset formation, the less risk.

Debt to Equity Ratio — Total Liabilities divided by Total Equity. The smaller the ratio, the greater the long-term solvency.

Profitability Ratios

Net Income to Sales — After-tax Profits divided by Annual Sales. This key profit ratio indicates the company’s profit as a percentage of sales.

Gross Profit to Sales — Pre-tax Profit divided by Sales. A downward trend in this ratio might indicate you need to raise prices to remain profitable.

Operating Expense to Sales — Accounts Payable divided by Annual Sales. Higher numbers indicate the use of suppliers to float operations.

Return on Total Assets — Net Profit divided by Total Assets, is a key indicator of profitability


About this entry