1/22/2017 20BalanceSheetRatiostoQuicklyDetermineaCompany'sHealth

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20 Balance Sheet Ratios to Determine a

Companys Health
February 26, 2013

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Financial ratio analysis has come a long way.
The US stock market and the businesses in USA are superb because of the
transparency offered to investors.

It is not perfect, but compared to the rest of the world, the access to nancial
statements and thus the variety of nancial ratios that you can crunch is world class.

With that, I want to go through 20 balance sheet ratios to help you determine the
nancial health of a company. These balance sheet ratios can be applied to both the
public and private sector.

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You will note that most of these balance sheet ratios are basic, which makes it easy to
calculation. Simple ratios and ideas are often the best, overlooked and forgotten.

At the end of the article, you can download a pdf of the 20 balance sheet ratios.

Now, lets get started on the balance sheet ratios refresher.

A Refresher on Balance Sheet Ratios

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1/22/2017 20BalanceSheetRatiostoQuicklyDetermineaCompany'sHealth

The Balance Sheet

Solvency Ratios

Solvency Ratios are quick and easy to calculate and easy to interpret.

The objective is to see whether a company has enough cash, assets and low debt to
continue operations without running into nancial trouble.

Quick Ratio

Quick Ratio =(Current Assets Inventories) / Current Liabilities

The quick ratiomeasuresa companysability to meetits short-term obligations withits

most liquid assets. The higher the quick ratio,thebetter the position of thecompany.

Current Ratio

Current Ratio= Current Assets / Current Liabilities

An even simpler variant to the quick ratio and is used to determine the companys
ability to pay back its short term liabilities. Youll see this balance sheet ratio
everywhere.

If the ratio is below 1, it raises a warning sign as to whether the company is able to pay
its short term obligations when due. It doesnt mean the company will go bankrupt, but
is something that has to be looked at. If a company has a low current ratio year after
year, it could be a characteristic of the industry where companies operate and high debt
levels.

Debt/Equity Ratios

Total Debt/Equity Ratio =Total Liabilities / Shareholders Equity

Long Term Debt/Equity Ratio =Long Term Debt / Shareholders Equity

Short Term Debt/Equity Ratio =Short Term Debt / Shareholders Equity

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1/22/2017 20BalanceSheetRatiostoQuicklyDetermineaCompany'sHealth

There are different variations of the debt to equity ratios, but the objective of these
nancial ratios is to determine how a company has been nancing its growth.

A high ratio means that the company has been growing due to debt. Not all debt is bad,
but if the number is exceedingly high, remember that the company has to pay off the
loan as well as interest payments.

An important factor to consider then is to determine whether the returns generated

from the debt exceeds the cost of debt (i.e. interest).

Activity Ratios

Activity nancial ratios measure how well a company is able to convert its assets in the
balance sheet into cash or sales. By analyzing the activity ratios, you can see how
efcient and well run a company is.

These nancial metrics arent just for the company, but also measures the people
behind the business and how well they are running the show.

Days Sales Outstanding (DSO)

Days Sales Outstanding= (Receivables/ Revenue) x 365

Cash is king and a business capable of converting its receivables into cash quickly is a
great sign of health and efciency.

A lowDSO number means that it takes a company fewer days to collect its accounts
receivable.A high DSO numbershows that a company is sellingits product to
customers on credit and taking longer to collectmoney.

Days Inventory Outstanding (DIO)

Days Inventory Outstanding= (Inventory / COGS) x 365

This nancial ratio is used to measure the average number of days a company holds
inventory before selling it.

This ratio is industry specic and should be used to compare competitors. A company
like Boeing will have vastly different DIO than a company like Amazon where inventory
turnover is high.

Days Payable Outstanding (DPO)

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Days Payable Outstanding= (Accounts Payable / COGS) x 365

Days Payable Outstanding shows the time in days a business has to pay back its
creditors. On the ip side, it also shows how long the company can utilize the cash
before paying it back.

The longer a company can delay payments, the better.

Cash Conversion Cycle

Cash Conversion Cycle = DIO + DSO DPO

Putting DIO, DSO and DPO together, you get the cash conversion cycle.

Theentire cash conversion cycle is a measure of management effectiveness. The

lower the better, and a great way to compare competitors.

For a full explanation as well as company comparisons and examples, check out the
article on cash conversion cycle
(http://www.oldschoolvalue.com/blog/accounting/the-cash-conversion-cycle-to-help-
you-pick-winners-and-losers/).

Turnover Ratios

Receivables Turnover = Revenue / Average Accounts Receivables

The receivables turnover ratio is one that is categorized as an activity ratio because it
measures the companys effectiveness in collecting its credit sales.

Inventory Turnover = COGS / Average of Inventory

Inventory is money. It costs money to buy, it costs money to just hold it because it
takes up a lot of overhead if it isnt cleared out. You waste shelf space, the product gets
old and it may have to be sold at a fraction of the price just to get rid of it.

Inventory turnover is important for companies with physical products and is best used
to compare against peers. After all, the inventory turnover for a retailer like Wal-Mart is
going to be very different to a car company like Ford.

Average Age of Inventory (Days)

Average Age of Inventory =Average of Inventory / Revenue

Average age of inventory is just the inverse of Inventory Turnover.

Ive separated the two because it is easier to visualize the inventory age in days. Lets
say that the inventory turnover for Safeway is 10. But it just makes it easier to visualize
the inventory when it is described as 36.5 days instead of a turnover ratio of 10.

Intangibles to Book Value Ratio

This balance sheet metric is helpful in checking the quality, as well as the health.

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Unless a company holds a lot of valuable intellectual property or well known brands, I
like to see intangibles kept low. This is a simple balance sheet analysis to show how of
the company is built on intangibles.

Intangibles to Book Value = Intangibles / Book Value

Inventory to Sales Ratio

Inventory to Sales = Inventory / Revenue

A rather simple and less used ratio. It is mostly useful when you track it year over year
or every quarter.

The objective is to see how inventory is being managed as it will signal potential
problems with cash ow.

An increase in the inventory to sales ratio can indicate that

your investment in inventory is growing more rapidly than sales

or sales are dropping
Vice versa, if the inventory to sales ratio drops, it could mean that
your investment in inventory is shrinking in relation to sales
sales are increasing

This is a high level balance sheet ratio but it will point you in the right direction when you need to dive
deeper into inventory trends.

Capital Structure Ratios

Capital structure is looking at the companys debt and equity. The following ratios all
help to show you how much a company is using debt to run the business.

These are easy balance sheet ratios to understand and offer a quick check for red
ags.

LT-Debt as % of Invested Capital = Long Term Debt / Invested Capital

ST-Debt as % of Invested Capital =Short Term Debt / Invested Capital

where Invested Capital = Shareholders Equity + Total Liabilities Current Liabilities

Excess Cash

Debt to Equity Ratios

Watch how these ratios have trended in order to understand whether the company is in
a difcult situation or not. If a company operates on high leverage and has maintained
a high debt ratio, it is not as alarming as a company with a low debt ratio suddenly
showing a spike in the debt ratio.

LT-Debt to Total Debt = Long Term Debt / Total Debt

The long term debt ratio is an indicator that the company does not have enough cash
to run future operations. Look into the deal for the debt, what the interest payments are,
what level of operation the company has to achieve in order to remain within the debt
covenant.

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1/22/2017 20BalanceSheetRatiostoQuicklyDetermineaCompany'sHealth

ST-Debt to Total Debt =Short Term Debt / Total Debt

If the short term debt ratio is high, this is a big warning sign. The debt payment is
coming due and has to be re-negotiated or paid off with a new loan.

There are situations where a high short term debt ratio will cause high levels of
uncertainty and the stock to sell off.

Total Liabilities to Total Assets = Total Liabilities / Total Assets

A broad ratio to show the level of liabilities on the balance sheet compared to the
assets.

Price to Working Capital = Price / Working Capital per Share

where Working Capital = Current Assets Current Liabilities

Working capital is the absolute lifeblood of a company. Most fast growing and
successful businesses die due to a lack of working capital. Thats why most companies
went public in the rst place; to get more working capital from the public market.

A high working capital ratio shows whether the business can continue to operate
without troubles.

For retailers, you would want subtract inventory from the working capital equation to
get a better picture.

Download the 20 Balance Sheet Ratios

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