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.
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