FINANCIAL RATIOSExamining these ratios over time provides some insight as to how effectively the business is being operated. Also, comparing your business to industry averages and quartiles is useful. Robert Morris & Associates (RMA) is a good source of such comparative financial ratios. BUT PLEASE REMEMBER THESE ARE ONLY GUIDES THEY ARE NO SUBSTITUTE FOR STRATEGY.

1. Liquidity: Liquidity measures a company's capacity to pay its debts as they come due.

a. Current Ratio: Total Current Assets / Total Current Liabilitiesi. Gauges how capable a business is in paying current liabilities by using

current assets. The actual quality and management of assets must also be considered.

b. Quick Ratio: (Cash + Accounts Receivable) / Total Current Liabilities i. Focuses on immediate liquidity. Quick assets are highly liquid and are

immediately convertible to cash. If there are receivable accounts included in the numerator, they should be collectible.

2. Safety: indicates a company's vulnerability to risk (based on the business' debt).

a. Debt to Equity: Total Liabilities / Total Equityi. Quantifies the relationship between the capital invested by owners and

investors and the funds provided by creditors. The higher the ratio, the greater the risk to a current or future creditor. A lower ratio means your client's company is more financially stable. However, extremely low indicate too conservative.

b. Interest Coverage Ratio: EBITDA / Interest Expensei. This assesses the company's ability to meet interest payments. It also

evaluates the capacity to take on more debt. The higher the ratio, the greater the company's ability to make interest payments/take on debt.

3. Profitability: measures the company's ability to generate a return on its resources.

a. Gross Profit Margin: Gross Profit / Salesi. Indicates the return at the gross profit level. It addresses three areas --

inventory control, pricing and production efficiency. It indicates how many cents of gross profit generated by sales.

b. Net Profit Margin: Adjusted Net Profit before Taxes / Salesi. Shows measures how many cents of profit the company generates per

dollar of sales. Track it carefully against industry competitors. This is a very important number in preparing forecasts.

4. Efficiency: evaluates how well the company manages its assets.

a. Accounts Receivable Turnover: Sales / Accounts receivablei. Shows the number of times accounts receivable are paid and reestablished

during the accounting period. The higher the turnover, the faster the business is collecting its receivables and the more cash on hand.

b. Inventory Turnover: COGS / Inventoryi. This ratio shows how many times in one accounting period the company

turns over (sells) its inventory and is valuable for spotting under-stocking, overstocking, obsolescence and the need for merchandising improvement. Faster turnovers are generally viewed as a positive trend; they increase cash flow and reduce warehousing and other related costs.

c. Payroll to Sales: Payroll Expense / Salesi. This metric shows payroll expense for the company as a percentage of

sales, which indicates the efficiency with which HR is employed.

d. Fixed Asset Turnover: Sales / Gross Fixed Assetsi. This indicator measures how well fixed assets are "throwing off" sales and

is very important to businesses that require significant fixed assets.

e. Return on Assets: Net Income / Total Assetsi. Measures the company's ability to use its assets to create profits. ROA

indicates how many cents of profit each dollar of asset is producing per year. It indicates how managers use the assets available to them.

f. Return on Equity: Net Income / Total Equityi. Determines the rate of return on the invested capital. It is used to compare

investment in the company against other investment opportunities, such as stocks, real estate, savings, etc. There should be a direct relationship between ROI and risk (i.e., the greater the risk, the higher the return).