Common Financial Ratios for Year End Reviews

Use financial ratios to compare year to year performance. Ratios will indicate a trend of better or worse than last year. Calculating these ratios will require a Balance Sheet and a Profit and Loss statement


BALANCE SHEET RATIOS (Liquidity)

• Current Ratio (Solvency) divide Current Assets by Current Liabilities to measure dollars of assets per dollar of debt shows ability to pay debts.
• Quick Ratio (Liquidity) divide  Cash plus Accounts Receivable by Current Liabilities to measure CASH available to pay debts show ability to quickly pay debts.
• Debt-to Worth (Safety) divide Total Liabilities by Net Worth to measure Dollars of Liabilities per dollar of net worth
• Working Capital divide Current Assets minus Current Liabilities by Sales to measure ability to pay short term debt
• Cash divide Cash plus equivalents by Total Assets to measure CASH as a percent of total assets

INCOME STATEMENT RATIOS (Profitability)

• Gross Margin divide Gross Profit by Sales to measure percent of sales available to cover operating expenses
• Net Margin (Profit) divide Pre-Tax Profit by Sales to measure percent of sales that becomes profits

ASSET MANAGEMENT RATIOS (Overall Efficiency)

• Sales-to-Assets divide Sales by Total Assets to measure efficiency of assets used to make sales
• Return on Assets divide Pre-Tax Profit  by Total Assets to measures efficiency of assets to produce profits 
• Return on Equity divide Pre-Tax Profits by Stockholder Equity to measure efficiency of owners equity to produce profits

ASSET MANAGEMENT RATIOS (Working Capital Cycle)

• Inventory Turns divide Average COGS by Inventory to measures how many times per year dollars of inventory turn over
• Inventory Days divide 365 by Inventory Turns to measure how many days it take to turn over inventory
• Accounts Receivable Turns divide Sales by Accounts Receivable to measure how many times per year accounts receivable turn over
• Accounts Receivable Days divide 365 by Accounts Receivable Turns to measures how many days it takes to collect accounts receivable

FINANCING RATIOS

• Debt to Equity divide Total Liabilities by Stockholder Equity to measure how much debt relative to each $1 of Equity  
• Interest Coverage divide Pre-Tax Profits plus Interest Exp by Interest Expense to measures ability to pay interest expenses
• Debt to Assets divide Total Liabilities by Total Assets to measure percent of assets needed to cove debts
• Debt Service Coverage divide Pre-Tax Profits by Total Debt Service to measures dollars available to cover debt service

FINANCIAL DIAGNOSIS COMMON CAUSES

1. Low Current Ratio; caused by Current Liabilities too high; using short term debt to buy long term assets; .
2. Low Quick Ratio;  caused by Current Liabilities too high; using short term debt to buy long term assets; or too much inventory.
3. High Debt to Equity; caused by Equity too low or liabilities too high 
4. Low Gross Profit Margin; caused by Poor Pricing, Poor Product Mix, Poor Productivity, Spoilage, Shrinkage
5. Low Pre-Tax Profit Margin; caused by Low Gross Profit Margin, Overhead too high 
6. Low Sales to Assets; caused by Low Sales, High Assets 
7. Low Return on Assets; caused by Low Pre-Tax Profits, High Assets
8. Low Return on Investment; caused by Low Pre-Tax Profit, High Equity 
9. Low Inventory Turnover; caused by Inventory too high
10. Low Accounts Receivable Turnover; caused by Accounts Receivable too high