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Balance Sheet Ratio

UNDERSTANDING BALANCE SHEETS

Balance Sheet Ratio: Every financial statement reader should know

The balance sheet is one of the significant documents that is analyzed in a business. Balance sheets give a glimpse of the company’s financial position: we can see in the balance sheet the company’s cash position, assets, debts (short term and long term) and other obligations.

With the aid of some handy computations which can be gathered from the balance sheet, a company can better interpret their financial status. The following examples include the most common balance sheet ratios used to analyze the balance sheet:

CURRENT RATIO

The current ratio can be calculated as current assets divided by current liabilities. It measures the company’s ability to meet its upcoming liabilities as to when they mature.

We can calculate a business Current Ratio by utilizing the data presented on the balance sheet.

QUICK RATIO

Another helpful balance sheet metric is the Quick Ratio which is identified as a more rigorous way of analyzing the liquidity of the company.

The quick ratio is similar to the current ratio except that it takes inventory out of the equation. Its for the reason that inventory carried on the balance sheet does not necessarily mean it can be converted to cash at the book value. It assumes that inventory is slower to convert to cash than other liquid assets and it indicates the relationship between the amount of assets that can quickly be turned into cash versus the amount of current liabilities.

 

DEBT TO EQUITY

One of the most important ratios that can be derived from a balance sheet is the debt-to-equity ratio. The debt-to-equity ratio shows which proportion the company to finance its assets and operations. It is reflected in the balance sheet which shows to what extent the company is dependent upon debt and is calculated by dividing the total debt to total shareholder’s equity:

 

INTERNAL EQUITY RATIO

Internal Equity Ratio (which can be extracted from the balance sheet) measures how well the company is using its shareholder’s investments to generate profits and is calculated by dividing the total shareholder’s equity by total assets. Thus, all the assets and equity disclosed in the balance sheet are covered in the equity ratio calculation.

Higher equity ratios are considered a positive sign for companies because it means that the company is worth investing in. Consequently, a higher ratio means that the company is sustainable and has less chances of having future loans.

On the other hand, a low equity ratio is not necessarily bad for the business. It just shows that if the business is profitable, the ROI could also be high. However, if the company’s result is unprofitable, the interest expense associated with the debt could affect the cash flow.

Prospect investors prefer to regard a high equity ratio since it means that a company is well-managed.

From the information obtained in the balance sheet, we can calculate the equity ratio using this formula:

CONCLUSION

Balance sheet ratios compare the different line items on a balance sheet in order to infer the liquidity, efficiency and financial structure of a business.

These calculations serve as a guide to better understand a company’s financial status and balance sheet. By analyzing the information found in the balance sheet and apply the quick calculations discussed in this article, we can expect a better understanding of the company’s performance in general.

Get in touch today to get a free ratio review for your company.

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