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Balance Sheet Ratios Essay

1101 words - 5 pages

Balance sheet ratios
The important ratios that arise from the Balance Sheet include working capital, liquidity, net worth, debtors turnover, return on assets and return on investment.

Working capital ratio

This ratio is also known as "the current ratio", and is one of the best-known measures of financial strength. The main question this ratio addresses is: "Does your business have enough current assets to meet the payment schedule of its current debts with a margin of safety for possible losses in current assets, such as stock shrinking or uncollectable debtors?"
A generally acceptable current ratio is 2:1; but whether or not a specific ratio is satisfactory, depends on the ...view middle of the document...

• Convert non-current assets into current assets.
• Increase your current assets from taking in new equity contributions.
• Put profits back into your business, rather than drawing them out by way of salaries etc.

Liquidity ratio

This ratio is also called "the quick ratio", and is known as the "acid test ratio" because it is one of the best measures of liquidity. This ratio is used to determine the solvency of your business or its ability to meet its immediate commitments. The liquid ratio is a much more exacting measure than the current ratio. By leaving out stocks and other non-cash assets, it concentrates clearly on assets that are liquid with a value that is fairly certain. It will answer the question of: "If all sales revenue should disappear, could my business meet its current obligations with the funds on hand or that can be easily accessed?" A ratio of 1:1 is considered satisfactory unless the majority of your quick assets are in debtors and there is a pattern of debtors lagging behind rather than paying their accounts on time. It is often referred to as the acid test. In calculating this ratio it is important to bring in only those current assets that are in cash or can be converted readily into cash. Similarly current liabilities brought in must only be those that need to be met quickly.
The formula for this ratio is:
Current Assets – (Stock & other non-cash assets)
Current Liabilities – (Liabilities not payable in the short-term)
= $120,000 – ($16,000 + $10,000)
$80,000 – $3,000
= $94,000
$77,000
= 1.22 : 1.00
This means that there is $1.22 in cash or near cash assets to meet every $1.00 of immediate commitment.

Net worth ratio

This ratio measures the adequacy of the owner’s funds as it indicates the proportion of the total asset of the business that is owned by him or her. Net worth is calculated by subtracting all liabilities from total assets to arrive at the balance, which are the owner’s fund.
The formula for this ratio is:
Net Worth x 100 networth/total assets *100
Total Assets 1
= $120,000 x 100
$360,000 1
= 33.33%
In this case the owners have funded 33.33% of the business assets.
Debtors turnover ratio
This ratio indicates how well debtors are being...

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