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Cash Flow-Solvency Ratios

Accounts Payable: Business Revenue: Accounts Payable/Annual Business Revenue, measuring the speed with which a company pays vendors relative to Business Revenue. Numbers higher than typical industry ratios suggest that the company may be using suppliers to float operations.

Current Ratio: This is the same as Current Assets/Current Liabilities, measuring 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. The Quick Ratio is applied as a more stringent test.

Quick Ratio: (Cash plus Accounts Receivable)/Current Liabilities, indicating liquid assets available to cover current debt. 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.

Days Payables: 365/(Cost of Sales: Accounts Payable ratio): Reflects the average number of days for each payable before payment is made.

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

Net Working Capital: Business Revenue: Net Working Capital/Business Revenue. Indicates if a company is maintaining a reasonable level of liquidity relative to its Business Revenue volume. A high ratio indicates an overly conservative reliance on liquid assets, while low ratios suggests the opposite.

Cost of Sales: Accounts Payable: Measures the number of times payables turn over in the course of the year. High measures may indicate cash flow concerns.

Cost of Sales: Inventory: Reflects the number of times inventory is turned over during the course of the year. High levels can mean good liquidity or Business Revenue, or shortages requiring better management. Low levels may indicate poor cash flow or overstocking.

Profitability Ratios

EBITDA: Business Revenue: Earnings Before Interest, (income) Taxes due, Depreciation and Amortization/Business Revenue. EBITDA: Business Revenue is a relatively controversial (and often criticized) metric designed to eliminate the effect of finance and accounting decisions when comparing companies and industry benchmarks. Tax credits and deferral procedures and non-cash expenditures (Amortization and Depreciation) are not deducted from the profit equation, as are interest expenditures.

Return on Assets: Pre-Tax or After Tax Net Profit/Total Assets, a critical indicator of profitability. Companies which use their assets efficiently will tend to show a ratio higher than the industry norm. The ratio may appear higher for small businesses due to owner compensation draws accounted as net profit.

Return on Net Worth: Pre-Tax or After Tax Net Profit/Net Worth. This is the 'final measure' of profitability to evaluate overall return. This ratio measures return relative to investment, how well a company leverages the investment in it. May appear higher for small businesses due to owner compensation draws accounted as net profit.

Return on Business Revenue: Pre-Tax or After Tax Net Profit Net Profit/Annual Business Revenue, indicating the level of profit from each dollar of Business Revenue. This ratio can be used as a predictor of the company's ability to withstand changes in prices or market conditions. May appear higher for small businesses due to owner compensation draws accounted as net profit.

Discretionary Owner Earnings: Sums Officer Compensation, Depreciation and related non cash expenses and Net Profit after business taxes to represent a practical measure of total return to owners. The D.O.E. metric is mainly used for small businesses.

Efficiency Ratios

Assets: Business Revenue: Total Assets/Business Revenue, indicating whether a company is handling too high a volume of Business Revenue in relation to investment. Very low percentages relative to industry norms might indicate overly conservative sales efforts or poor sales management.

Days Inventory: 365/(Cost of Sales: Inventory): The average number of days of items in inventory.

Days Receivables: 365/(Business Revenue/Receivables): Reflects the number of days that receivables are outstanding. Target average or lower.

Current Asset Turnover: Business Revenue/Current Assets. A general indicator of the efficiency of asset use. Target at or slightly below industry level.

Fixed Asset Turnover: Business Revenue/Fixed Assets. An indicator of the efficiency of investment in fixed asset such as plant and equipment. Target at or slightly below industry level.

Gross Margin: Business Revenue: Pre-tax Gross Profit/Annual Business Revenue. This is the profit ratio before product and Business Revenue costs, as well as taxes. This ratio can indicate the "play" in other expenses which could be adjusted to increase the Net Profit margin.

Sales per Employee: Business Revenue/FTE Employees: A basic efficiency measure developed outside the formal financial statement, often reflecting relative value-added. Higher is usually better.

Inventory Turnover: Business Revenue/Inventory. This ratio gives a picture of how quickly inventory turns over. Ratios below the industry norm suggest high levels of inventory. High ratios could indicate product levels insufficient to satisfy demand in a timely manner. Target: at or slightly above industry level.

Receivables Turnover: Business Revenue/Receivables. An indicator of how efficiently invoiced sales are collected. Target at or slightly above industry level.

Total Asset Turnover: Business Revenue/Total Assets. Target: at or slightly below industry level.

Working Capital Turnover: Business Revenue divided by Net Working Capital (current assets minus current liabilities). Ratios higher than industry norms may indicate a strain on available liquid assets, while low ratios may suggest too much liquidity. Target: at or above industry level.

Days Working Capital: 365/ (Working Capital Turnover): Expresses the coverage in number of days of available working capital.

Cash Turnover: Business Revenue/Cash. Indicates efficiency in the use of cash to develop Business Revenue. A more stringent ratio than Working Capital Turnover (below). Target at or slightly below industry level.

Debt-Risk Ratios

Interest Coverage: EBITDA/Interest Expense: Earnings before Interest, (income) Taxes due, Depreciation and Amortization divided by Interest expense. Assesses financial stability by examining whether a company is at least profitable enough to pay interest expense. A ratio >1.00 indicates it is. See cautions in the listing for EBITDA.

Current Liabilities: Net Worth: Total Current Liabilities/Net Worth, a measure of short-term debt coverage (>1 year). This ratio reflects a level of security for creditors. The larger the ratio relative to industry norms, the less security there is for creditors.

Long-Term Liabilities: Net Worth: Long-Term Liabilities/Net Worth, a measure of coverage of long-term debt (>1 year).

Loans/Notes Payable: Net Worth: The Loans/Notes Payable portion of current liabilities divided by Net Worth, a measure of debt coverage.

Modified Z-Score: A modified form of the Altman Z-Score which evaluates default risk. The modified Z-Score substitutes Discretionary Owner Earnings for Net Profit and Net Worth for Retained Earnings to better capture small business operations. In all cases higher (at or above the industry level) is desired. Modified Z-Score calculations for this industry are:

For manufacturing industries: ([Working Capital/Total Assets]*0.717) + ([Discretionary Owner Earnings/Total Assets]*0.847) + ([Operating Income/Total Assets]*3.107) + ([Net Worth/Total Liabilities]*0.420) + ([Sales/Total Assets]*.998)

For all non-manufacturing industries: ([Operating Income/Total Assets]*6.72) + ([Net Worth/Total Liabilities]*1.05) + ([Working Capital/Total Assets]*6.5) + ([Discretionary Owner Earnings/Total Assets]*3.26)

Total Liabilities: Net Worth: Total Liabilities/Net Worth, a measure of coverage of total debt (short and long-term). Creditors are concerned to the extent that total liability levels exceed Net Worth.

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