In order to make the best use of the three financial statements, business owners need to know how to interpret and compare particular data on them. There are five key ratios:
Current Ratio-(Current Asset/ Current Liabilities) A liquidity ratio that measures the quality and adequacy of current assets to meet current liabilities. In other words, can a company quickly convert its assets to cash in order to meet the immediate and short-term obligations.
Sales to Receivable Ratio-(Sales/Receivables) A liquidity ratio that measures the number of times trade receivables turn over during the year. The higher the turnover of receivables, the shorter the time between sale and cash collection.
Cost of Sales to Inventory Ratio-(Cost of Sales/Inventory) A liquidity ratio that measures the number of times inventory turns over during the year. The higher the turnover of inventory, the shorter the time cash is tied up in inventory the sooner inventory is converted to cash therefore, increasing liquidity.
Debt to Equity-(Debt/Equity) A leverage ratio that measures how well a company is managing its debt and whether the company is reinvesting in itself or taking on more debt. It expresses the relationship between capital contributed by creditors and that contributed by shareholder.
Profit Margin Ratio-(Profit/Sales) Measures a company’s profitability and how much “cushion” it has.
Return on Assets-(Income/Assets) An operating ratio that measures the effective use of assets in generating earnings.
Profit Margin Ratio-(Profit/Sales) Measures a company’s profitability and how much “cushion” it has.
Return on Assets-(Income/Assets) An operating ratio that measures the effective use of assets in generating earnings.
Interpreting key financial ratios correctly allows business owners to act quickly. Immediate corrective action increases efficiency and profitability -- two improvements all business owners want!
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