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Balance Sheet Financial Ratio Analysis

What is ratio analysis? The Balance Sheet and the Statement of
Income are essential, but they are only the starting point for
successful financial management. Apply Ratio Analysis to
Financial Statements to analyze the success, failure, and progress
of your business.
Ratio Analysis enables the business owner/manager to spot
trends in a business and to compare its performance and
condition with the average performance of similar businesses in
the same industry. To do this compare your ratios with the
average of businesses similar to yours and compare your own
ratios for several successive years, watching especially for any
unfavorable trends that may be starting. Ratio analysis may
provide the all-important early warning indications that allow you
to solve your business problems before your business is
destroyed by them.
Balance Sheet Ratio Analysis Formula
Important Balance Sheet Ratios measure liquidity and solvency (a
business's ability to pay its bills as they come due) and leverage
(the extent to which the business is dependent on creditors'
funding). They include the following ratios:
Liquidity Ratios
These ratios indicate the ease of turning assets into cash. They
include the Current Ratio, Quick Ratio, and Working Capital.
Current Ratios. The Current Ratio is one of the best known
measures of financial strength. It is figured as shown below:
Current Ratio =
Total Current Assets
Total Current Liabilities

could my business meet its current obligations with the readily convertible `quick' funds on hand?" .  Increasing your current assets from loans or other borrowings with a maturity of more than one year. it concentrates on the really liquid assets. but that relationship is usually playing it too close for comfort. Quick Ratios.The main question this ratio addresses is: "Does your business have enough current assets to meet the payment schedule of its current debts with a margin of safety for possible losses in current assets. But whether or not a specific ratio is satisfactory depends on the nature of the business and the characteristics of its current assets and liabilities. with value that is fairly certain. The minimum acceptable current ratio is obviously 1:1. The Quick Ratio is sometimes called the "acidtest" ratio and is one of the best measures of liquidity.  Increasing your current assets from new equity contributions. It helps answer the question: "If all sales revenues should disappear. If you decide your business's current ratio is too low.  Converting non-current assets into current assets. you may be able to raise it by:  Paying some debts. It is figured as shown below: Quick Ratio = Cash + Government Securities + Receivables ______________________________________ Total Current Liabilities The Quick Ratio is a much more exacting measure than the Current Ratio.  Putting profits back into the business. such as inventory shrinkage or collectable accounts?" A generally acceptable current ratio is 2 to 1. By excluding inventories.

Leverage Ratio This Debt/Worth or Leverage Ratio indicates the extent to which the business is reliant on debt financing (creditor money versus owner's equity): Debt/Worth Ratio = Total Liabilities _______________ Net Worth Generally. Working Capital.An acid-test of 1:1 is considered satisfactory unless the majority of your "quick assets" are in accounts receivable. It measures the percentage . Income Statement Ratio Analysis The following important State of Income Ratios measure profitability: Gross Margin Ratio This ratio is the percentage of sales dollars left after subtracting the cost of goods sold from net sales. The result of this calculation must be a positive number. Working Capital is more a measure of cash flow than a ratio. and the pattern of accounts receivable collection lags behind the schedule for paying current liabilities. Loans are often tied to minimum working capital requirements. especially if you are relying to any significant extent on creditor money to finance assets. the higher this ratio. AÂ general observation about these three Liquidity Ratios is that the higher they are the better.Total Current Liabilities Bankers look at Net Working Capital over time to determine a company's ability to weather financial crises. the more risky a creditor will perceive its exposure in your business. It is calculated as shown below: Working Capital = Total Current Assets . making it correspondingly harder to obtain credit.

of sales dollars remaining (after obtaining or manufacturing the goods sold) available to pay the overhead expenses of the company. The Net Profit Margin Ratio is calculated as follows: Net Profit Margin Ratio = Net Profit Before Tax _____________________ Net Sales Management Ratios Other important ratios.Cost of Goods Sold) Net Profit Margin Ratio This ratio is the percentage of sales dollars left after subtracting the Cost of Goods sold and all expenses. It is calculated before income tax because tax rates and tax liabilities vary from company to company for a wide variety of reasons. It is important because the more times inventory can be turned in a . often referred to as Management Ratios. It provides a good opportunity to compare your company's "return on sales" with the performance of other companies in your industry. are also derived from Balance Sheet and Statement of Income information. The Gross Margin Ratio is calculated as follows: Gross Margin Ratio = Gross Profit _______________ Net Sales (Gross Profit = Net Sales . Comparison of your business ratios to those of similar businesses will reveal the relative strengths or weaknesses in your business. except income taxes. making comparisons after taxes much more difficult. Inventory Turnover Ratio This ratio reveals how well inventory is being managed.

The Return on Assets Ratio is calculated as follows: Return on Assets = Net Profit Before Tax ________________________ Total Assets Return on Investment (ROI) Ratio. If receivables are excessively slow in being converted to cash.given operating cycle. If receivables are not collected reasonably in accordance with their terms. liquidity could be severely impaired. A low ratio in comparison with industry averages indicates an inefficient use of business assets. the greater the profit. . The Accounts Receivable Turnover Ratio is calculated as follows: Net Credit Sales/Year __________________ = Daily Credit Sales 365 Days/Year Accounts Receivable Turnover (in days) = Accounts Receivable _________________________ Daily Credit Sales Return on Assets Ratio This measures how efficiently profits are being generated from the assets employed in the business when compared with the ratios of firms in a similar business. The Inventory Turnover Ratio is calculated as follows: Inventory Turnover Ratio = Net Sales ___________________________ Average Inventory at Cost Accounts Receivable Turnover Ratio This ratio indicates how well accounts receivable are being collected. management should rethink its collection policy.

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