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Liquidity Ratio

Liquidity ratio, expresses a company's ability to repay short-term creditors out of its total cash. The liquidity ratio is the result of dividing the total cash by short-term borrowings. It shows the number of times short-term liabilities are covered by cash. If the value is greater than 1.00, it means fully covered. The formula is the following: = cash & equivalents / creditors,short

Liquidity Ratio may refer to:


Reserve requirement, a bank regulation that sets the minimum reserves each bank must hold. Acid Test (Liquidity Ratio), a ratio used to determine the liquidity of a business entity.

Liquidity ratio, expresses a company's ability to repay short-term creditors out of its total cash. The liquidity ratio is the result of dividing the total cash by short-term borrowings. It shows the number of times short-term liabilities are covered by cash. If the value is greater than 1.00, it means fully covered. The formula is the following: LR = liquid assets / short-term liabilities.
Liquidity Ratios:
Liquidity Ratios are ratios that come off the the Balance Sheet and hence measure the liquidity of the company as on a particular day i.e the day that the Balance Sheet was prepared. These ratios are important in measuring the ability of a company to meet both its short term and long term obligations.

FIRST LIQUIDITY RATIO


Current Ratio: This ratio is obtained by dividing
the 'Total Current Assets' of a company by its 'Total Current Liabilities'. The ratio is regarded as a test of liquidity for a company. It expresses the 'working capital' relationship of current assets available to meet the company's current obligations.

The formula:
Current Ratio = Total Current Assets/ Total Current Liabilities

An example from our Balance sheet:


Current Ratio = $261,050 / $176,522 Current Ratio = 1.48

The Interpretation:
Lumber & Building Supply Company has $1.48 of Current Assets to meet $1.00 of its Current Liability

Review the Industry Norms in the same industry.

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SECOND LIQUIDITY RATIO


Quick Ratio: This ratio is obtained by dividing
the 'Total Quick Assets' of a company by its 'Total Current Liabilities'. Sometimes a company could be carrying heavy inventory as part of its current assets, which might be obsolete or slow moving. Thus eliminating inventory from current assets and then doing the liquidity test is measured by this ratio. The ratio is regarded as an acid test of liquidity for a company. It expresses the true 'working capital' relationship of its cash, accounts receivables, prepaids and notes receivables available to meet the company's current obligations.

The formula:
Quick Ratio = Total Quick Assets/ Total Current Liabilities Quick Assets = Total Current Assets (minus) Inventory

An example from our Balance sheet:


Quick Ratio = $261,050- $156,822 / $176,522 Quick Ratio = $104,228 / $176,522 Quick Ratio = 0.59

The Interpretation:
Lumber & Building Supply Company has $0.59 cents of Quick Assets to meet $1.00 of its Current Liability Review the Industry Norms in the same industry.

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THIRD LIQUIDITY RATIO


Debt to Equity Ratio: This ratio is obtained
by dividing the 'Total Liability or Debt ' of a company by its 'Owners Equity a.k.a Net Worth'. The ratio measures how the company is leveraging its debt against the capital employed by its owners. If the liabilities exceed the net worth then in that case the creditors have more stake than the shareowners.

The formula:
Debt to Equity Ratio = Total Liabilities / Owners Equity or Net Worth

An example from our Balance sheet:

LUMBER & BUILDING SUPPLY CO.

DEC31,1999 Balance Sheet


Cash Notes receivables Accounts receivables Inventory $ 1,896 $ 4,876 $ 97,456 $ 156,822 Notes payable, bank Notes receivable, discounted Accounts payable Accruals $ 14,000 $ 4,842 $ 152,240 $ 5,440

Total Current Assets

$ 261,050

Total Current Liabilities

$ 176,522

Land and buildings Equipment and fixtures Prepaid expenses

$ 46,258 $ 11,458 $ 1,278

Mortgage (Loans)

$ 10,000

Total Liabilities

$ 186,522

Networth

$ 133,522

Total Assets

$ 320,044

Total Liabilities and Networth

$ 320,044

Debt to Equity Ratio = $186,522 / $133,522 Debt to Equity Ratio = 1.40

The Interpretation:
Lumber & Building Supply Company has $1.40 cents of Debt and only $1.00 in Equity to meet this obligation. Review the Industry Norms in the same industry.

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Financial Statement Analysis - Efficiency Ratios

Efficiency Ratios:
Efficiency ratios are ratios that come off the the Balance Sheet and the Income Statement and therefore incorporate one dynamic statement, the income statement and one static statement , the balance sheet. These ratios are important in measuring the efficiency of a company in either turning their inventory, sales, assets, accounts receivables or payables. It also ties into the ability of a company to meet both its short term and long term obligations. This is because if they do not get paid on time how will you get paid paid on time. You may have perhaps heard the excuse 'I will pay you when I get paid' or 'My customers have not paid me!'

FIRST EFFICIENCY RATIO


DSO (Days Sales Outstanding): The Days Sales Outstanding
ratio shows both the average time it takes to turn the receivables into cash and the age, in terms of days, of a company's accounts receivable. The ratio is regarded as a test of Efficiency for a company. The effectiveness with which it converts its receivables into cash. This ratio is of particular importance to credit and collection associates. Best Possible DSO yields insight into delinquencies since it uses only the current portion of receivables. As a measurement, the closer the regular DSO is to the Best Possible DSO, the closer the receivables are to the optimal level. Best Possible DSO requires three pieces of information for calculation:


Formula:

Current Receivables Total credit sales for the period analyzed The Number of days in the period analyzed

Best Possible DSO = Current Receivables/Total Credit Sales X Number of Days

The formula:
Regular DSO = (Total Accounts Receivables/Total Credit Sales) x Number of Days in the period that is being analyzed

An example from our Balance sheet and Income Statement:


Total Accounts Receivables (from Total Credit Sales (from

Balance Sheet) = $97,456

Income Statement) = $727,116

Number of days in the period = 1 year = 360 days ( some take this number as 365 days) DSO = [ $97,456 / $727,116 ] x 360 = 48.25 days

The Interpretation:
Lumber & Building Supply Company takes approximately 48 days to convert its accounts receivables into cash. Compare this to their Terms of Net 30 days. This means at an average their customers take 18 days beyond terms to pay. Review the Industry Norms in the same industry.

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SECOND EFFICIENCY RATIO

Inventory Turnover ratio: This ratio is obtained

by dividing the 'Total Sales' of a company by its 'Total Inventory'. The ratio is regarded as a test of Efficiency and indicates the rapiditity with which the company is able to move its merchandise.

The formula:
Inventory Turnover Ratio = Net Sales / Inventory

It could also be calculated as: Inventory Turnover Ratio = Cost of Goods Sold / Inventory An example from our Balance sheet and Income Statement:
Net Sales = $727,116 (from

Income Statement) Balance sheet )

Total Inventory = $156,822 (from

Inventory Turnover Ratio = $727,116/ $156,822 Inventory Turnover = 4.6 times

The Interpretation:
Lumber & Building Supply Company is able to rotate its inventory in sales 4.6 times in one fiscal year. Review the Industry Norms and Ratios for this ratio to compare their efficiency and see if they are above, below or equal to the others in the same industry. To use the Inventory Turnover Ratio Calculator Click here

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THIRD EFFICIENCY RATIO


Accounts Payable to Sales (%): This ratio is obtained
by dividing the 'Accounts Payables' of a company by its 'Annual Net Sales'. This ratio gives you an indication as to how much of their suppliers money does this company use in order to fund its Sales. Higher the ratio means that the company is using its suppliers as a source of cheap financing. The working capital of such companies could be funded by their suppliers..

The formula:
Accounts Payables to Sales Ratio = [Accounts Payables / Net Sales ] x 100

An example from our Balance sheet and Income Statement:


Accounts Payables = $152,240 (from

Balance sheet )

Net Sales = $727,116 (from

Income Statement)

Accounts Payables to Sales Ratio = [$152,240 / $727,116] x 100 Accounts Payables to Sales Ratio = 20.9%

The Interpretation:
21% of Lumber & Building Supply Company's Sales is being funded by its suppliers.

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Profitability Ratios:
Profitability Ratios show how successul a company is in terms of generating returns or profits on the Investment that it has made in the business. If a business is Liquid and Efficient it should also be Profitable.

FIRST PROFITIBILITY RATIO


Return on Sales or Profit Margin (%): The Profit Margin of a company
determines its ability to withstand competition and adverse conditions like rising costs, falling prices or declining sales in the future. The ratio measures the percentage of profits earned per dollar of sales and thus is a measure of efficiency of the company.

The formula:
Return on Sales or Profit Margin = (Net Profit / Net Sales) x 100

An example from our Balance

sheet and Income Statement: Income Statement) = $5,142

Total Net Profit after Interest and Taxes (from

Net Sales (from

Income Statement) = $727,116

Return on Sales or Profit Margin = [ $5,142 / $727,116] x 100 Return on Sales or Profit Margin = 0.71%

The Interpretation:
Lumber & Building Supply Company makes 0.71 cents on every $1.00 of Sale

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SECOND PROFITABILITY RATIO


Return on Assets: The Return on Assets of a company
determines its ability to utitize the Assets employed in the company efficiently and effectively to earn a good return. The ratio measures the percentage of profits earned per dollar of Asset and thus is a measure of efficiency of the company in generating profits on its Assets.

The formula:
Return on Assets = (Net Profit / Total Assets) x 100

An example from our Balance

sheet and Income Statement: Income Statement) = $5,142

Total Net Profit after Interest and Taxes (from

Total Assets (from

Balance sheet) = $320,044

Return on Assets = [ $5,142 / $320,044] x 100 Return on Assets = 1.60%

The Interpretation:
Lumber & Building Supply Company generates makes 1.60% return on the Assets that it employs in its operations.

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Industry Norms and Ratios for this ratio to compare and see if they are above below or equal to the click here
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THIRD PROFITABILITY RATIO


Return on Equity or Net Worth: The Return on Equity of a company
measures the ability of the management of the company to generate adequate returns for the capital invested by the owners of a company. Generally a return of 10% would be desirable to provide dividents to owners and have funds for future growth of the company

The formula:
Return on Equity or Net Worth = (Net Profit / Net Worth or Owners Equity) x 100 Net Worth or Owners Equity = Total Assets (minus) Total Liability

An example from our Balance

sheet and Income Statement: Income Statement) = $5,142

Total Net Profit after Interest and Taxes (from

Net Worth (from

Balance sheet) = $133,522

Return on Net Worth = [ $5,142 / $133,522] x 100 Return on Equity or Return on Net Worth = 3.85%

The Interpretation:
Lumber & Building Supply Company generates a 3.85% percent return on the capital invested by the owners of the company.

Review the others in the same industry.

Industry Norms and Ratios for this ratio to compare and see if they are above below or equal to the click here

To use the Return on Assets or Profit Margin Calculator

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