Title: Balance sheet ratios

Using ratios for analysis

Read about each ratio, examine the example balance sheet in the unit above, and then calculate the ratio yourself. Finally, flip the card to check your result and read commentary.

Q: Quick Ratio =
(Current Assets – Inventories) / Current Liabilities

Tells us whether we can pay our short term debts with the money we have or can get our hands on quickly.
A: Quick Ratio =
(Current Assets – Inventories) / Current Liabilities

($16,000 -$10,000) / $16,000 = .375

This is awful.  This company doesn’t have the capacity to pay its short term obligations with the cash or near cash assets at its disposal.

Q: Current Ratio = Current Assets / Current Liabilities

A broader ratio addressing our ability to pay debts due in the coming year with the resources we have.
A: Current Ratio = Current Assets / Current Liabilities

$16,000 /$16,000 = 1

Still a miserable ratio. A banker would cross the street to avoid this business.

Q: Working Capital = Current Assets – Current Liabilities

Every business needs money to make the wheels turn working capital tells us how much grease is on the wheels .
A: Working Capital = Current Assets – Current Liabilities

$16,000 - $16,000 = 0

You can’t get far in the business world with no working capital.

Q: Total Debt/Equity Ratio =
Total Liabilities / Owners Equity

This ratio addresses the appropriate balance between the two kinds of capital, debt and equity.
A: Total Debt/Equity Ratio =
Total Liabilities / Owners Equity

$56,000 / $13,000 = 4.3

Your banker would not even be willing to lend you his pencil. A good ratio is about .4 so that means a company with only $13K in capital shouldn’t have more than $5,200 in total debt. Whether that’s realistic or not for a small business in the fledgling stages is another matter. But one can see that the objective has to be the formation of capital through earnings that stay in the company. Calculated another way, if a company has $56K in debt, ideally it would be supported by a foundation of $140,000 in equity.