Current Ratio or Working Capital Ratio

1、current ratio or working capital ratiothe formula:current ratio = total current assets total current liabilitiesinterpretation:the current ratio measures a businesss ability to pay its debts in the normal course of business operations. if they cant, creditors may force the business to close (go bank

2、rupt).norm:2.5 and abovevery good2.0good1.5 fair1.0poorless than 1precarious*working capital = current assets current liabilities- this is also an indication of a businesss ability to pay its debts in the normal course of business.recommendations:if a company needs to improve its current ratio, it m

3、ight consider using profits to pay off liabilities. it might also consider using owner investment, rather than bank loans to pay for future expansion, or purchases of new equipment. in other words, reduce the bottom of the fraction in the equation, or increase the top of the fraction.quick ratio or

4、acid-test ratiothe formula:quick ratio = total current assets(less inventory andprepaid expenses total current liabilitiesinterpretation:the calculation of the quick ratio differs from the calculation of the current ratio in that it includes only quick assets, those that can be converted into cash q

5、uickly. therefore, it measures ability to pay debt within a short period of time (say, 2 months). if a business cant it may be advised to stop operating as a business.norm:less than 1 is undesirable, but not uncommon. less than, say 0.7 is precarious.recommendations:if a company needs to improve its

6、 quick ratio, it could consider following the same steps suggested in the recommendations for the current ratio. if the ratio is very low, the business should consider closing.debt and equity percentagesthe formulas:debt ratio = total liabilitiestotal assetsequity ratio =total equitytotal assetsinte

7、rpretation:the debt ratio shows what proportion of the total assets are financed with borrowed money. the equity ratio shows what proportion of the total assets are financed with shareholders money. the two ratios will always add up to 100%, so if you know one, the other is easy to find. (i.e. debt

8、ratio = 100 equity ratio)norm:the higher the equity ratio, the better. when the investors own a high percentage of the company, creditors and banks will have more confidence in that company. if the debt ratio is high, creditors will have questions about why so much of the company is claimed by credi

9、tors & the bank. (i.e., if your company is so good, why dont you own most of it?) sometimes, however, if a company is young and profitable, a high debt ratio may be acceptable for a few years, as long as profits are being used to decrease debt and increase equity.recommendations:if debt is high and

10、equity is low, a company might consider using profits to pay down debt, and to fund future expansion through investment rather than bank loans.rate of return on net salesthe formula:rate of return on net sales = net income x 100 net salesinterpretation:the rate of return on net sales measures the do

11、llars that remain after all expenses are deducted from net sales. comparing this figure with other years gives an indication of how well a company is performing.norm:companys like to see this percentage increasing over time. it is acceptable for a new company to have a negative number here. however,

12、 over time we want to see an increasing positive number. this percentage must be compared to other similar businesses, and past years. higher is better.recommendations:reducing expenses will increase the top part of the fraction, as net income = revenue expenses. so, a company will want to become mo

13、re efficient if this number is low. also, a company may want to consider the pricing of its product or service. perhaps increasing price will increase net income. be careful here however, as increased prices may decrease sales, and therefor have a negative impact on net income.rate of return on shar

14、eholders equitythe formula:rate of return on s. equity = net income x 100owners avg. equity = net income x 100beginning equity +ending equity2interpretation:the rate of return on shareholders equity measures how well the business is doing when compared with other investments the shareholders might m

15、ake using the capital from the business. in particular, the shareholders would be interested in knowing how much the equity could earn in interest if it could be loaned out.norm:this rate should be higher than current interest rates (5%-6%). higher is better. this rate should also compare well to ot

16、her similar companies.recommendations:net income must be increased. this can happen either through increased revenue, or more likely, decreased expenses.collection periodthe formula:collection period = accounts receivableaverage charge sales per day= accounts receivable charge sales /365interpretati

17、on:the collection period, or accounts receivable turnover figure gives an indication of how many days sales are represented by the account receivable. in other words, how long it takes customers to pay their bills. if this is too long it may mean that the company has allowed unreliable customers to

18、buy on credit, or that they need to get tough on customers who are taking their time paying up. norm:look at the terms offered to customers, generally you want this number to be less than one and one half the length of the payment terms. (i.e. 30 days to pay means you want the number to be less than

19、 45). be careful, a low number here may also be bad. a low number could mean that the company is not making enough sales on credit.recommendations:hire a credit collection company to hound your late-paying customers. train your accounting department to be more careful about who is allowed credit. hi

20、re a credit service to help investigate potential customers credit ratings before offering credit. offer incentives to customers who pay quickly. (discounts offered)inventory turnoverthe formula:inventory turnover = cost of goods soldaverage merchandise inventory= cost of goods sold beginning invent

21、ory+ending inventory 2interpretation:the inventory turnover figure represents the number of times a business has been able to sell and replace their inventory in a year.norm:a larger number is better. the less expensive, and more perishable the goods are, the more frequently they should be turned ov

22、er. (i.e. lexus turns inventory over less frequently than sobeys) in order to tell if the inventory turnover is good, you must compare to other similar companies.recommendations:to improve this number, a company must attempt to either increase sales through advertising, better location, better sales

23、 staff, or redecorating/reorganizing the store, or decrease the size of their inventory perhaps they are simply carrying too much inventory.times interest earned ratiothe formula:times interest earned = net income interest expenseinterpretation:the times interest earned ratio measures the companys a

24、bility to cover its interest expense. if a company has too much debt, they will be forced to pay the bank a lot of interest. this can be a sign that the company is in financial trouble. banks will avoid lending a company more money if that companys times interest earned ratio is too high.norm:higher

25、 is better. 5 or less is considered poor. a company should generally strive for a result of 8 or more. in other words, net income should be much greater (8 times) the amount of interest paid on loans.recommendations:if this number is low, the company should try to pay off debt with profits, and avoi

26、d borrowing more funds from the bank. earnings per sharethe formula:earnings per share = net income (after tax) number of common shares outstandinginterpretation:the earnings per share figure is used to measure the performance of a corporation and its executive officers. shareholders and prospective

27、 investors may use the figure to compare earning power over a number of periods. this helps them determine trends and stability. this number will also be compared to that of other companies in choosing investments.norm:higher is better. must be compared to other similar companies, and previous years results to determine trends, and performance.recommendations:increase profit (increase revenue, or decrease expenses).price earnings ratiothe formula:price earnings ratio = market price per share earnings per shareinterpreta