Generally a working capital ratio of 2:1 is regarded as desirable.

However the circumstances of every business
vary and you should consider how your business operates and set an appropriate benchmark ratio.
A stronger ratio indicates a better ability to meet ongoing and unexpected bills therefore taking the pressure off
your cash flow. eing in a li!uid position can also have advantages such as being able to negotiate cash discounts
with your suppliers.
A weaker ratio may indicate that your business is having greater difficulties meeting its short"term commitments
and that additional working capital support is re!uired. Having to pay bills#before payments are received may be
the issue in which case an overdraft could assist. Alternatively building up a reserve of cash investments may
create a sound working capital buffer.
$atios should be considered over a period of time %say three years&' in order to identify trends in the performance
of the business.
(he calculation used to obtain the ratio is:

)orking *apital $atio +
*urrent Assets
*urrent ,iabilities
Acid-Test Ratio
What Does Acid-Test Ratio Mean?
A stringent test that indicates whether a firm has enough short-term assets to cover its immediate liabilities without selling
inventory. The acid-test ratio is far more strenuous than the working capital ratio, primarily because the working capital ratio
allows for the inclusion of inventory assets.
Calculated by:
Investopedia explains Acid-Test Ratio
Companies with ratios of less than 1 cannot pay their current liabilities and should be looked at with etreme caution.
!urthermore, if the acid-test ratio is much lower than the working capital ratio, it means current assets are highly dependent on
inventory. "etail stores are eamples of this type of business.
The term comes from the way gold miners would test whether their findings were real gold nuggets. #nlike other metals, gold
does not corrode in acid$ if the nugget didn%t dissolve when submerged in acid, it was said to have passed the acid test. &f a
company%s financial statements pass the figurative acid test, this indicates its financial integrity.
What Does Acid-Test Ratio Mean?
A stringent test that indicates whether a firm has enough short-term assets to cover its immediate liabilities without selling
inventory. The acid-test ratio is far more strenuous than the working capital ratio, primarily because the working capital ratio
allows for the inclusion of inventory assets.
Calculated by:
Investopedia explains Acid-Test Ratio
Companies with ratios of less than 1 cannot pay their current liabilities and should be looked at with etreme caution.
!urthermore, if the acid-test ratio is much lower than the working capital ratio, it means current assets are highly dependent on
inventory. "etail stores are eamples of this type of business.
The term comes from the way gold miners would test whether their findings were real gold nuggets. #nlike other metals, gold
does not corrode in acid$ if the nugget didn%t dissolve when submerged in acid, it was said to have passed the acid test. &f a
company%s financial statements pass the figurative acid test, this indicates its financial integrity.
Debt/Equity Ratio
What Does Debt/Equity Ratio Mean?
A measure of a company%s financial leverage calculated by dividing its total liabilities by stockholders% e'uity. &t indicates what
proportion of e'uity and debt the company is using to finance its assets.

(ote: )ometimes only interest-bearing, long-term debt is used instead of total liabilities in the calculation.
Also known as the *ersonal +ebt,-'uity "atio, this ratio can be applied to personal financial statements as well as companies%.
Investopedia explains Debt/Equity Ratio
A high debt,e'uity ratio generally means that a company has been aggressive in financing its growth with debt. This can result
in volatile earnings as a result of the additional interest epense.
&f a lot of debt is used to finance increased operations .high debt to e'uity/, the company could potentially generate more
earnings than it would have without this outside financing. &f this were to increase earnings by a greater amount than the debt
cost .interest/, then the shareholders benefit as more earnings are being spread among the same amount of shareholders.
0owever, the cost of this debt financing may outweigh the return that the company generates on the debt through investment
and business activities and become too much for the company to handle. This can lead to bankruptcy, which would leave
shareholders with nothing.
The debt,e'uity ratio also depends on the industry in which the company operates. !or eample, capital-intensive industries
such as auto manufacturing tend to have a debt,e'uity ratio above 1, while personal computer companies have a debt,e'uity of
under 2.3.
Calculatin Debt-to-Equity
The debt-to-e'uity ratio offers one of the best pictures of a company%s leverage. The formula is straightforward:
! Total "iabilities / Total #ha$eholde$s% Equity
4uite simply, the higher the figure, the higher the leverage the company employs. (otice that this ratio uses all liabilities .short-
term and long-term/, and all owner%s e'uity .both invested capital and retained earnings/.
Inte$p$etin the Ratio
5et%s say a company has long-term debt of 612 million in the form of a bond outstanding and e'uity of 612 million. The debt-to-
e'uity ratio is 1 .12,1271/. &f the same company has the bond outstanding and only 61 million in e'uity, then the debt-to-e'uity
ratio is 12 .12,1712/. This company is probably in big trouble. Alternatively, if the company has the 612 million bond outstanding
and 612 million in e'uity, giving a debt-to-e'uity ratio of 2.3, investors can feel a little bit more comfortable. 8e can interpret a
debt-e'uity ratio of 2.3 as saying that the company is using 62.32 of liabilities in addition to each 61 of shareholders% e'uity in
the business.
9ranted, a company with no debt may be missing an opportunity to increase earnings by financing pro:ects that will give a better
return than the cost of the debt. A little debt can be good for a company%s earnings. ;n the other hand, a high debt-to-e'uity
ratio translates into higher risk for shareholders since creditors are always first in line for compensation should the company go
bankrupt. )hareholders must wait at the back of the 'ueue for dibs on assets.
&n the big picture, the debt-e'uity ratio tells us that debt isn%t bad as long as there is a sufficient amount of e'uity. 8hen an
investor buys e'uity it reflects positively on the company%s outlook. ;n the other hand, it%s a bad situation when a company can
only raise money by issuing debt.