The quick ratio tests whether a business can meet its obligations even if adverse conditions occur. Assets considered to be "quick" assets include cash, stocks and bonds, and accounts receivable in other words, all of the current assets on the balance sheet except inventory.
Using the balance sheet data for the Doobie Company, we can compute the quick ratio for the company. In general, quick ratios between 0. So the Doobie Company seems to have an adequate quick ratio. In this section we will look at four that are widely used. There may be others that are common to your industry, or that you will want to create for a specific purpose within your company.
The inventory turnover ratio measures the number of times inventory "turned over" or was converted into sales during a time period. It is also known as the cost-of-sales to inventory ratio. It is a good indication of purchasing and production efficiency.
The data used to calculate this ratio come from both the company's income statement and balance sheet. Here is the formula:. Using the financial statements for the Doobie Company, we can compute the following inventory turnover ratio for the company:. In general, the higher a cost of sales to inventory ratio, the better. A high ratio shows that inventory is turning over quickly and that little unused inventory is being stored.
The sales-to-receivables ratio measures the number of times accounts receivables turned over during the period. The higher the turnover of receivables, the shorter the time between making sales and collecting cash. A reminder: net sales equals sales less any allowances for returns or discounts. Net receivables equals accounts receivable less any adjustments for bad debts. This ratio also uses information from both the balance sheet and the income statement.
It is calculated as follows:. Using the financial statements for the Doobie Company and assuming that the Sales reported on their income statement is net Sales , we can compute the following sales- to-receivables ratio for the company:. This means that receivables turned over nearly 12 times during the year. This is a ratio that you will definitely want to compare to industry standards.
Keep in mind that its significance depends on the amount of cash sales a company has. For a company without many cash sales, it may not be important. Also, it is a measure at only one point in time and does not take into account seasonal fluctuations. The days' receivables ratio measures how long accounts receivable are outstanding. Business owners will want as low a days' receivables ratio as possible. After all, you want to use your cash to build your company, not to finance your customers.
Also, the likelihood of nonpayment typically increases as time passes. The "" in the formula is simply the number of days in the year.
The sales receivable ratio is taken from the calculation we did just a few paragraphs earlier. Using the financial statements for the Doobie Company, we can compute the following day's receivables ratio for the company. This means that receivables are outstanding an average of 31 days. Again, the real meaning of the number will only be clear if you compare your ratios to others in the industry. The return on assets ratio measures the relationship between profits your company generated and assets that were used to generate those profits.
Return on assets is one of the most common ratios for business comparisons. It tells business owners whether they are earning a worthwhile return from the wealth tied up in their companies. In addition, a low ratio in comparison to other companies may indicate that your competitors have found ways to operate more efficiently. Publicly held companies commonly report return on assets to shareholders; it tells them how well the company is using its assets to produce income. These ratios are of particular interest to bank loan officers.
They should be of interest to you, too, since solvency ratios give a strong indication of the financial health and viability of your business. It shows how much of a business is owned and how much is owed. Using balance sheet data for the Doobie Company, we can compute the debt-to-worth ratio for the company. If the debt-to-worth ratio is greater than 1, the capital provided by lenders exceeds the capital provided by owners. Bank loan officers will generally consider a company with a high debt-to-worth ratio to be a greater risk.
Debt-to-worth ratios will vary with the type of business and the risk attitude of management. Working Capital Working capital is a measure of cash flow, and not a real ratio. It represents the amount of capital invested in resources that are subject to relatively rapid turnover such as cash, accounts receivable and inventories less the amount provided by short-term creditors.
Working capital should always be a positive number. Lenders use it to evaluate a company's ability to weather hard times. The ratios presented below represent some of the standard ratios used in business practice and are provided as guidelines. Not all these ratios will provide the information you need to support your particular decisions and strategies.
You can also develop your own ratios and indicators based on what you consider important and meaningful to your organization and stakeholders.
How well is our business performing over a specific period, will your social enterprise have the financial resources to continue serving its constituents tomorrow as well as today? How efficiently are you utilizing your assets and managing your liabilities? These ratios are used to compare performance over multiple periods. Does your enterprise have enough cash on an ongoing basis to meet its operational obligations?
This is an important indication of financial health. To what degree does an enterprise utilize borrowed money and what is its level of risk? You may want to develop your own customized ratios to communicate results that are specific and important to your organization.
Here are some examples. Skip to main content. For ratios to be useful and meaningful, they must be: Calculated using reliable, accurate financial information does your financial information reflect your true cost picture?
Calculated consistently from period to period Used in comparison to internal benchmarks and goals Used in comparison to other companies in your industry Viewed both at a single point in time and as an indication of broad trends and issues over time Carefully interpreted in the proper context, considering there are many other important factors and indicators involved in assessing performance.
Ratios can be divided into four major categories: Profitability Sustainability Operational Efficiency Liquidity Leverage Funding — Debt, Equity, Grants The ratios presented below represent some of the standard ratios used in business practice and are provided as guidelines. The Ratios Profitability Sustainability Ratios How well is our business performing over a specific period, will your social enterprise have the financial resources to continue serving its constituents tomorrow as well as today?
Ratio What does it tell you? If overall costs and inflation are increasing, then you should see a corresponding increase in sales. If not, then may need to adjust pricing policy to keep up with costs.
The nature and risk of each revenue source should be analyzed. Is it recurring, is your market share growing, is there a long term relationship or contract, is there a risk that certain grants or contracts will not be renewed, is there adequate diversity of revenue sources? Organizations can use this indicator to determine long and short-term trends in line with strategic funding goals for example, move towards self-sufficiency and decreasing reliance on external funding.
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Your Practice. Popular Courses. Part Of. Introduction to Company Valuation. Fundamental Analysis Basics. Fundamental Analysis Tools and Methods. Valuing Non-Public Companies. What Is Ratio Analysis? Key Takeaways Ratio analysis compares line-item data from a company's financial statements to reveal insights regarding profitability, liquidity, operational efficiency, and solvency. Ratio analysis can mark how a company is performing over time, while comparing a company to another within the same industry or sector.
While ratios offer useful insight into a company, they should be paired with other metrics, to obtain a broader picture of a company's financial health. Compare Accounts. The offers that appear in this table are from partnerships from which Investopedia receives compensation. This compensation may impact how and where listings appear.
Analysts compare financial ratios to industry averages benchmarking , industry standards or rules of thumbs and against internal trends trends analysis. The most useful comparison when performing financial ratio analysis is trend analysis.
Financial ratios are used in Flash Reports to measure and improve the financial performance of a company on a weekly basis. Liquidity ratios measure whether there will be enough cash to pay vendors and creditors of the company. Some examples of liquidity ratios include the following:.
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