Ratios analyze a business’s financial condition. There are four basic categories of ratios: Liquidity, Profitability, Net Worth, and Turnover.
Liquidity Ratios –
- Quick Ratio – measures quick assets to current liabilities. It’s a benchmark for proper amounts of cash, accounts receivable and marketable securities.
- Current Ratio – defined as current assets to current liabilities. This measures asset coverage in case of liquidation. May vary with different types of business’s, but normally the ratio should be 2:1 assets to liabilities.
Profitability Ratios –
- Profit Margin – method of reviewing a business’s profit as a percentage of sales. Net income is used, but gross profit may be exchanged in the calculation.
- Profit on Net Worth – amount of net income in relation to equity designates the way capitalized funds are put in action.
Net Worth Ratios –
- Fixed Assets to Net Worth – this is the association between investment in capital equipment and the company’s equity. Specifies whether capitalized funds can support fixed assets.
- Total Liabilities to Net Worth – this ratio provides a risks rating between creditors and investors. Values of 1:1 or greater indicate creditors have more at risk in the business than investors.
- Current Liabilities to Net Worth – links short term liabilities with net worth and expresses a purer depiction of the source of funds for business operation.
Turnover Ratios –
- Sales to Net Working Capital – business’s net current assets are not expressly committed to paying of business debt. Therefore, management has the right to allocate them.
- Sales to Inventory – in most business’s, inventory signifies the main investment. The turnover rate of this asset is a signal of the efficiency which the company handles its funds.
- Sales to Account Receivable – If a company’s sales are turning on a 30 days basis, this should turn receivables around 12 times per year.
- Collection Cycle – the average number of days required to collect receivables can be calculated by dividing the accounts receivable turnover into 365 days. There are complex ways to figure this method. Collection cycle could relate to the selling terms of the business.
This information may be useful in understanding the financial operation of a business.