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# Liquidity Ratios Efficiency Ratios Profitability Ratios

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 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 same industry.

Norms and Ratios for this ratio to compare and see if they are above below or equal to the others in the

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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:

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.

and Ratios for this ratio to compare and see if they are above below or equal to the others

## To use the Debt to Equity Ratio Calculator Click here

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iency 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

## 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 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

## 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 others in the same industry.

and Ratios for this ratio to compare their efficiency and see if they are above, below or equal to the

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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. Review the Industry Norms in the same industry.

and Ratios for this ratio to compare and see if they are above below or equal to the others