Financial Ratios Based on the Balance Sheet

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					Financial Ratios Based on the Balance Sheet


Financial statement analysis includes financial ratios. Here are three financial ratios that
are based solely on current asset and current liability amounts appearing on a company's
balance sheet:



 Financial Ratio                How to Calculate It                  What It Tells You

 Working           = Current Assets – Current Liabilities An indicator of whether the
 Capital                                                  company will be able to meet its
                   = $89,000 – $61,000                    current obligations (pay its bills,
                                                          meet its payroll, make a loan
                   = $28,000                              payment, etc.) If a company has
                                                          current assets exactly equal to
                                                          current liabilities, it has no working
                                                          capital. The greater the amount of
                                                          working capital the more likely it
                                                          will be able to make its payments on
                                                          time.
 Current Ratio     = Current Assets ÷ Current Liabilities This tells you the relationship of
                                                          current assets to current liabilities. A
                   = $89,000 ÷ $61,000                    ratio of 3:1 is better than 2:1. A 1:1
                                                          ratio means there is no working
                   = 1.46                                 capital.

 Quick Ratio       = [(Cash + Temp. Investments +          This ratio is similar to the current
 (Acid Test          Accounts Receivable) ÷ Current        ratio except that Inventory, Supplies,
 Ratio)              Liabilities] : 1                      and Prepaid Expenses are excluded.
                                                           This indicates the relationship
                   = [($2,100 + $100 + $10,000 +           between the amount of assets that
                     $40,500) ÷ $61,000] : 1               can quickly be turned into cash
                                                           versus the amount of current
                   = [$52,700 ÷ $61,000] : 1               liabilities.

                   = 0.86 : 1
Four financial ratios relate balance sheet amounts for Accounts Receivable and Inventory
to income statement amounts. To illustrate these financial ratios we will use the following
income statement information:




                                      Example Corporation
                                       Income Statement
                             For the year ended December 31, 2009

                       Sales (all on credit)                 $500,000
                       Cost of Goods Sold                     380,000
                        Gross Profit                          120,000
                       Operating Expenses
                        Selling Expenses                       35,000
                        Administrative Expenses                45,000
                         Total Operating Expenses              80,000
                       Operating Income                        40,000
                        Interest Expense                       12,000
                       Income before Taxes                     28,000
                         Income Tax Expense                     5,000
                       Net Income after Taxes                $ 23,000

To learn more about the income statement, go to:

      Explanation of Income Statement
      Drills for Income Statement
      Crossword Puzzle for Income Statement


 Financial Ratio             How to Calculate It                What It Tells You

 Accounts          = Net Credit Sales for the Year ÷    The number of times per year that
 Receivable          Average Accounts Receivable for    the accounts receivables turn over.
 Turnover            the Year                           Keep in mind that the result is an
                                                        average, since credit sales and
                   = $500,000 ÷ $42,000 (a computed     accounts receivable are likely to
                     average)                           fluctuate during the year. It is
                                                        important to use the average balance
                   = 11.90                              of accounts receivable during the
                                                        year.
                   = 365 days in Year ÷ Accounts        The average number of days that it
 Days' Sales in     Receivable Turnover in Year          took to collect the average amount
 Accounts                                                of accounts receivable during the
 Receivable        = 365 days ÷ 11.90                    year. This statistic is only as good as
                                                         the Accounts Receivable Turnover
                   = 30.67 days                          figure.

 Inventory         = Cost of Goods Sold for the Year ÷   The number of times per year that
 Turnover            Average Inventory for the Year      Inventory turns over. Keep in mind
                                                         that the result is an average, since
                   = $380,000 ÷ $30,000 (a computed      sales and inventory levels are likely
                     average)                            to fluctuate during the year. Since
                                                         inventory is at cost (not sales value),
                   = 12.67                               it is important to use the Cost of
                                                         Goods Sold. Also be sure to use the
                                                         average balance of inventory during
                                                         the year.
 Days' Sales in    = 365 days in Year ÷ Inventory        The average number of days that it
 Inventory           Turnover in Year                    took to sell the average inventory
                                                         during the year. This statistic is only
                   = 365 days ÷ 12.67                    as good as the Inventory Turnover
                                                         figure.
                   = 28.81



The next financial ratio involves the relationship between two amounts from the balance
sheet: total liabilities and total stockholders' equity:



 Financial Ratio                How to Calculate It               What It Tells You

 Debt to Equity    = (Total liabilities ÷ Total          The proportion of a company's assets
                     Stockholders' Equity) : 1           supplied by the company's creditors
                                                         versus the amount supplied the
                   = ( $481,000 ÷ $289,000) : 1          owner or stockholders. In this
                                                         example the creditors have supplied
                   = 1.66 : 1                            $1.66 for each $1.00 supplied by the
                                                         stockholders.
ers.