A balance sheet reports the company’s assets, liabilities, and shareholder equity at a specific point in time. In every balance sheet, assets must equal the total of your liabilities and equity, meaning the dollar amount must zero out.
Assets = (Liabilities + Equity)
Your balance sheet can help you determine how efficiently you’re generating revenue and how quickly you’re selling inventory. There are three types of ratios that can be computed from your balance sheet:
- Liquidity ratios are portions of the company’s assets and current liabilities. They are used to measure a business’s ability to pay short-term debts. A few liquidity ratios include:
- Current ratio measures the ability to cover short-term liabilities with a business’s current assets. A value of less than one means your business doesn’t have sufficient liquid resources.
- Current Ratio = Current Assets ÷ Current Liabilities
- Quick ratio refines current ratio by measuring the level of the most liquid current assets available to cover liabilities.
- Quick Ratio = (Cash Equivalents + Marketable Securities + Accounts Receivable) ÷ Current Liabilities
Interest coverage measures the ability to pay interest expense from the cash you generate. A value less than 1.5 usually concerns lenders.
Net working capital is the aggregate amount of all your current assets and liabilities and is calculated by subtracting current liabilities from current assets.
Net Working Capital = Current Assets – Current Liabilities
Leverage ratios look at how much capital comes in the form of a debt (or loan). Too much debt can be dangerous for a business and turn off investors. Some leverage ratios you can use include:
Debt to equity measures the proportion of shareholder equity and debt used to finance a business’s assets. High debt to equity indicates that a company might not be generating enough cash for its debt obligations. It’s calculated by dividing total liabilities by shareholder equity.
Debt to Equity Ratio = Total Liabilities ÷ Shareholder Equity
Debt to capital assesses the ratio of all short-term and long-term debts against total capital. To calculate this, take the company’s debt divided by its total capital.
Debt to Capital Ratio = Company’s Debt ÷ Total Capital
Debt to EBITDA (earnings before taxes, interest, depreciation, and amortization) is used to determine a business’s ability to pay debt. Debts include both short-term and longer-term debts. The EBITDA is the company’s total earnings before interest, taxes, and depreciation. Calculate this by taking your business’s interest-bearing liabilities minus cash equivalents, divided by EBITDA.
Debt to EBITDA Ratio = (Interest-Bearing Liabilities – Cash Equivalents) ÷ EBITDA
Interest coverage showcases the ability of a business to pay its interest expenses on an outstanding debt. A higher ratio indicates better financial health since it shows the business is able to meet interest obligations from operating earnings. Calculate this ratio by dividing earnings before interest and taxes (EBIT) by your business’s interest expenses for the same period.
Interest Coverage = EBIT ÷ Interest Expenses
Fixed charge coverage measures a business’s ability to meet its fixed-charge obligations, which could be fixed costs like insurance, salaries, auto loans, utilities, property taxes, or mortgages. Calculate it by taking (earnings before interest, depreciation, and amortization minus unfunded capital expenditures and distributions) divided by total debt service (annual principal and interest payments).
Fixed Charge Coverage = ([Earnings Before Interest + Depreciation + Amortization] – Unfunded Capital Expenditures and Distributions) ÷ Total Debt Service
Efficiency ratios measure a company’s ability to use its assets and manage liabilities to generate income. An efficiency ratio can help determine the following:
Inventory turnover measures how many times a business sold its total inventory over the past year, in dollar amount. A high ratio implies strong sales while a low turnover ratio implies weak sales and excess inventory. Take your cost of goods sold divided by average inventory to determine your turnover.
Inventory Turnover = COGS ÷ Average Inventory
Account receivable days measures how efficiently a firm uses assets and is calculated by dividing the net value of credit sales by the average accounts receivable.
Account Receivable Days = Net Value of Credit Sales ÷ Average Accounts Receivable
Total asset turnover showcases the business’s ability to generate sales from its assets. You can determine this by dividing the net sales by the average total assets
Total Asset Turnover = Net Sales ÷ Average Total Assets
Net asset turnover compares the value of a business’ sales relative to the value of its assets. Calculate your net asset turnover by taking your sales divided by your average total assets
Net Asset Turnover = Sales ÷ Average Total Asset