BALANCE SHEET RATIOS
CURRENT RATIO: current assets should be more than twice the
ACID TEST: liquid assets should be more than the current
INVENTORY RATIO: inventory should be less than 3/4 of the net
working capital in a small company and less than
the net working capital in a large company.
LONG-TERM DEBT RATIO: long-term debt should be less than the net
FIXED ASSETS RATIO: fixed assets should be less than 2/3 of the
tangible net worth in a small company and less
than 3/4 of the tangible net worth in a large
LIABILITIES RATIO: total liabilities should be less than the
tangible net worth. (This measures creditors'
interest vs owner's interest.)
CURRENT LIABILITIES RATIO: current liabilities should be less
than 2/3 of the tangible net worth of a small
company and less than 3/4 for a large company.
NET WORKING CAPITAL: current assets less the current
TANGIBLE NET WORTH: net worth less the intangible assets.
SMALL COMPANY: tangible net worth less than $250,000 (as of
1972; this could be adjusted for inflation) (<75%
of net working capital).
LARGE COMPANY: tangible net worth more than $250,000 (as of
1972; this could be adjusted for inflation) (<100%
of net working capital).
INCOME STATEMENT RATIOS
NET SALES TO INVENTORY
NET SALES TO TANGIBLE NET WORTH: measures net sales against the
NET SALES TO NET WORKING CAPITAL: examines the effect of net
sales on the ability of the company to meet emergencies.
NET PROFITS TO TANGIBLE NET WORTH: measures the efficiency of
the company management.
NET PROFITS TO NET SALES: measures the efficiency of operation
in a competitive situation. The "ultimate" test of a company.
AVERAGE COLLECTION PERIOD: examines the turnover of
receivables. Generally, should be no more than one-third greater
than the net selling terms.
( accounts_receivable ) / ( net_credit_sales / 365 )
Dun & Bradstreet
Fourteen Key Business Ratios
1984-85 Industry Norms and Key Business Ratios
D&B provides ratio analysis so you can compare your business to
others in your industry. This can really give you insight.
Quick Ratio is computed by dividing cash plus accounts receivable
by total current liabilities. Current liabilities are all the
liabilities that fall due within one year. This ratio reveals
the protection afforded short-term creditors in cash or near-cash
assets. It shows the number of dollars of liquid assets
available to cover each dollar of current debt. Any time this
ratio is as much as 1 to 1 (1.0) the business is said to be in a
liquid condition. The larger the ratio the greater the
Current Ratio. Total current assets are divided by total current
liabilities. Current assets include cash, accounts and notes
receivable (less reserves for bad debts), advances on
inventories, merchandise inventories, and marketable securities.
This ratio measures the degree to which current assets cover
current liabilities. The higher the ratio the more assurance
exists that the retirement of current liabilities can be made.
The current ratio measures the margin of safety available to
cover any possible shrinkage in the value of current assets.
Normally a ratio of 2 to 1 (2.0) or better is considered good.
Current Liabilities to Net Worth is derived by dividing current
liabilities by net worth. This contrasts the funds that
creditors temporarily are risking with the funds permanently
invested by the owners. The smaller the net worth and the larger
the liabilities, the less security for the creditors. Care
should be exercised when selling any firm with current
liabilities exceeding two-thirds (66.6 percent) of net worth.
Current Liabilities to Inventory. Dividing current liabilities
by inventory yields another indication of the extent to which the
business relies on funds from disposal of unsold inventories to
meet its debts. This ratio combines with Net Sales to Inventory
to indicate how management controls inventory. It is possible to
have decreasing liquidity while maintaining consistent sales-to-
inventory ratios. Large increases in sales with corresponding
increases in inventory levels can cause an inappropriate rise in
current liabilities if growth isn't made wisely.
Total Liabilities to Net Worth. Obtained by dividing total
current plus long-term and deferred liabilities by net worth.
The effect of long-term (funded) debt on a business can be
determined by comparing this ratio with Current Liabilities to
Net Worth. The difference will pinpoint the relative size of
long-term debt, which, if sizable, can burden a firm with
substantial interest charges. In general, total liabilities
shouldn't exceed net worth (100 percent) since in such cases
creditors have more at stake than owners.
Fixed Assets to Net Worth. Fixed assets are divided by net
worth. The proportion of net worth that consists of fixed assets
will vary greatly from industry to industry but generally a
smaller proportion is desirable. A high ratio is unfavorable
because heavy investment in fixed assets indicates that either
the concern has a low net working capital and is over-trading or
has utilized large funded debt to supplement working capital.
Also, the larger the fixed assets, the bigger the annual
depreciation charge that must be deducted from the income
statement. Normally, fixed assets above 75 percent of net worth
indicate possible over-investment and should be examined with
Collection Period. Accounts receivable are divided by sales and
then multiplied by 365 days to obtain this figure. The quality
of the receivables of a company can be determined by this
relationship when compared with selling terms and industry norms.
In some industries where credit sales are not the normal way of
doing business, the percentage of cash sales should be taken into
consideration. Generally, where most sales are for credit, any
collection period more than one-third over normal selling terms
(40.0 for 30-day terms) is indicative of some slow-turning
receivables. When comparing the collection period of one concern
with that of another, allowances should be made for possible
variations in selling terms.
Net Sales to Inventory. Obtained by dividing annual net sales by
inventory. Inventory control is a prime management objective
since poor controls allow inventory to become costly to store,
obsolete or insufficient to meet demands. The sales-to-inventory
relationship is a guide to the rapidity at which merchandise is
being moved and the effect on the flow of funds into the
business. This ratio varies widely between different lines of
business and a company's figure is only meaningful when compared
with industry norms. Individual figures that are outside either
the upper or lower quartiles for a given industry should be
examined with care. Although low figures are usually the biggest
problem, as they indicate excessively high inventories, extremely
high turnovers might reflect insufficient merchandise to meet
customer demand and result in lost sales.
Assets to Sales is calculated by dividing total assets by annual
net sales. This ratio ties in sales and the total investment
that is used to generate those sales. While figures vary greatly
from industry to industry, by comparing a company's ratio with
industry norms it can be determined whether a firm is overtrading
(handling an excessive volume of sales in relation to investment)
or undertrading (not generating sufficient sales to warrant the
assets invested). Abnormally low percentages (above the upper
quartile) can indicate overtrading which may lead to financial
difficulties if not corrected. Extremely high percentages (below
the lower quartile) can be the result of overly conservative or
poor sales management, indicating a more aggressive sales policy
may need to be followed.
Sales to Net Working Capital. Net sales are divided by net
working capital. (Net working capital is current assets minus
current liabilities.) This relationship indicates whether a
company is overtrading or conversely carrying more liquid assets
than needed for its volume. Each industry can vary substantially
and it is necessary to compare a company with its peers to see if
it is either overtrading on its available funds or being overly
conservative. Companies with substantial sales gains often reach
a level where their working capital becomes strained. Even if
they maintain and adequate total investment for the volume being
generated (Assets to Sales), that investment may be so centered
in fixed assets or other non-current items that it will be
difficult to continue meeting all current obligations without
additional investment or reducing sales.
Accounts Payable to Sales. Computed by dividing accounts payable
by annual net sales. This ratio measures how the company is
paying its suppliers in relation to the volume being transacted.
An increasing percentage, or one larger than the industry norm,
indicates the firm may be using suppliers to help finance
operations. This ratio is especially important to short-term
creditors since a high percentage could indicate potential
problems in paying vendors.
Return on Sales (Profit Margin) is obtained by dividing net
profit after taxes by annual net sales. This reveals the profits
earned per dollar of sales and therefore measures the efficiency
of the operation. Return must be adequate for the firm to be
able to achieve satisfactory profits for its owners. This ratio
is an indicator of the firm's ability to withstand adverse
conditions such as falling prices, rising costs and declining
Return on Assets. Net profit after taxes divided by total
assets. This ratio is the key indicator of profitability for a
firm. It matches operating profits with the assets available to
earn a return. Companies efficiently using their assets will
have a relatively high return while less well-run businesses will
be relatively low.
Return on Net Worth (Return on Equity) is obtained by dividing
net profit after tax by net worth. This ratio is used to analyze
the ability of the firm's management to realize an adequate
return on the capital invested by the owners of the firm.
Tendency is to look increasingly to this ratio as a final
criterion of profitability. Generally, a relationship of at
least 10 percent is regarded as a desirable objective for
providing dividends plus funds for future growth.
For further information, contact Dun & Bradstreet