Tips on Balance Sheet and Financial Ratios Research

Financial Ratios: Liquidity Measures

These financial ratios are generally understood as measures of firm and industry liquidity: All ratios are derived from balance sheet data.

1. Quick Ratio
(Cash + Accounts Receivable)/ Current Liabilities

The Quick Ratio indicates liquid assets available to cover current debt. It is also known as the Acid Ratio. This is a “harsher” version of the Current Ratio, which balances short-term liabilities against cash and liquid instruments. Generally, any value of less than 1 to 1 suggests an over-reliance on inventory or other current assets to pay off short-term debt.

2. Current Ratio
Current Assets/ Current Liabilities

The Current Ratio measures current assets available to cover current liabilities, a test of near-term solvency. The ratio indicates to what extent cash on hand and disposable assets are enough to pay off near term liabilities. Higher ratios indicate a better buffer between current obligations and a firm's ability to pay them. The quality of current assets is a critical factor in interpreting this analysis.

3. Current Liabilities to Net Worth
Current Liabilities / Net Worth

This ratio reflects a level of security for creditors. The larger the ratio relative to industry norms, the less security there is for creditors.

4. Total Liabilities to Net Worth
Total liabilities/ Net Worth

This ratio helps to clarify the impact of long-term debt, which can be seen by comparing this ratio with Current Liabilities: Net Worth. Creditors are concerned to the extent that total liability levels exceed Net Worth.

5. Sales to Net Working Capital
Sales/Net Working Capital
Note: Net Working Capital = (Current Assets-Current Liabilities)

The ratio is also discussed as an efficiency measure in the Financial Analysis Edge #5.
Sales-to-Net Working Capital levels higher than industry norms may indicate or a strain on available liquid assets, while low ratios may suggest too much liquidity – an inefficient use of capital. Working capital is a concern of measure of current creditors since it reflects ability to finance current operations. Comparing sales from operations to working capital indicates how well working capital is employed.

6. Fixed assets to Net Worth
Fixed Assets / Net Worth.

High Fixed Assets to Net Worth ratios relative to the industry can indicate low working capital or problematically high levels of debt.

7. Cash Turnover
Sales/Cash

This ratio reflect the number of times that cash in hand turns over in a year. As a comparison to sales, it is a more stringent measure of liquidity than the Current asset Turnover.

8. Current Asset Turnover
Current Assets/Cash

This ratio reflects the number of times that current assets turn over in a year. As a comparison to sales, it is a less stringent measure of liquidity than the Current asset Turnover.

9. Current Liabilities to Inventory
Current Liabilities / Inventory

A high Current Liabilities to Inventory ratio, relative to industry norms, suggests over-reliance on unsold goods to finance operations.

10. Cost of Sales to Inventory
Cost of Sales / Inventory

Related financial Ratio: Days’ Inventory
(Cost of Sales/Inventory) / 365

This financial ratio measures the number of times inventory is turned over during the year. High inventory turnover suggests good levels of liquidity. Conversely it can indicate a shortage of needed inventory for sales. Low inventory turnover can indicate poor liquidity, overstocking, or, more optimistically, a planned inventory buildup.

Days' Inventory measures the average length of time that product remains in inventory.

11. Cost of Sales to Accounts Payable
Cost of sales / Accounts Payable

Related Ratio: Days' Payables
365/ (Cost of sales / Accounts Payable)
This ratio measures the number of times that Accounts Payable turns over during the year relative to the Cost of Sales. Elevated turnover rates suggest a shorter time period between purchase and payment. Lower than industry rates may suggest cash shortages, or expansion of trade credit.

Days' Payables divides the basic ratio into 365 days, producing the average length of time trade debt is outstanding.

12. Accounts Receivables Turnover
Sales/ Accounts Receivable

Related financial ratio: Collection Period or Day’s Receivables
Accounts Receivable Turnover X 365

This ratio is also listed in the explanation of Efficiency Ratios in the Financial Analysis Edge #5.

This ratio measures the number of times that receivables turn over during the year. The higher the turnover of receivables, the shorter the time between sale and cash collection. If a company's Turnover Rate is significantly lower than industry norms, the underlying reason (poor collection methods, high risk customers, low sales) needs to be pinpointed.

The Day’s Sales Receivables measures the average time in days that receivables are outstanding. The higher the number of days outstanding, the greater the collection risk. The day’s receivables rate may suggest a concern over credit control and collections.

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