Business Financial Metrics
Financial metrics and ratios are very important to any business owner or entrepreneur. They illustrate the strengths and weaknesses of a company and, therefore, allow the business to make necessary changes in order to improve and grow. They are also great indicators of what the future holds for a business by analyzing what the trends are from past fiscal years or periods. It is very important for businesses to choose the right financial ratios for the business at hand. There are many different ratios. Some are industry specific and some apply to all industries. This paper will focus on the ratios and metrics used to evaluate the balance sheet and income statement.
The balance sheet is a very useful tool for any business. It lets the business owners, as well as investors and other interested parties, the financial stability of the company. Some of the financial metrics and ratios used to evaluate the balance sheet are: working capital, current ratio, quick ratio (acid test ratio), accounts receivable turnover, days’ sales in accounts receivable, inventory turnover, days’ sales in inventory, and debt to equity.
Working capital is an indicator of whether or not a business will be able to meet its current obligations (bills, payroll, loans, etc.) If a company’s current assets are equal to its current liabilities, it has no working capital. The greater a company’s working capital, the greater its ability to pay its bills on time. To compute working capital, simply subtract currently liabilities from current assets. This would be a very important thing for investors, managers and owners to look into. No one wants to invest in a company that is unlikely to be able to meet its obligations.
The current ratio tells you the relationship of current assets to current liabilities. A ratio with a higher first number (i.e., 3:1) would be preferred over a ratio such as 1:1, which would mean the company has no working capital. To compute the current ratio, simply divide current liabilities into current assets. The current ratio is another way for someone to find the working capital of a company and, therefore, would be something important for an investor, manager, or owner to look at.
The quick ratio, or acid test ratio, is similar to the current ratio except inventory, supplies, and prepaid expenses are not included. This ratio indicates the relationship between the assets that can quickly be turned into cash and the amount of current liabilities. To compute the quick ratio, add cash, temporary investments and accounts receivable, then divide current liabilities into that number. The ratio is then set to one. For example if after computing the quick ratio you came up with 0.86, the actual quick ratio would be: 0.86:1. This would be an important ratio to look at in order to determine the liquidity of a business.
The accounts receivable turnover is the number of times per year the accounts receivable turnover.