RATIOS

Applied Economics

Applied Economics

1) Liquidity Ratios

Current Ratio:

Formula

Current Assets / Current Liabilities

Measures the ability to meet current obligations in a timely manner, A healthy current ratio is greater than 2.

Improve by: Increase current assets by increasing profit, selling additional capital stock, borrowing additional long term debt, or disposing of unproductive fixed assets and retaining proceeds. Reduce current liabilities by retaining a greater portion of allocated savings(Watson, 2007). Avoid financing non-current assets with current liabilities.

Working Capital to Sales

Formula

Working Capital (Current Assets minus Current Liabilities) / Total Sales

Measures the degree that working capital should meet daily obligations in relation to business volume

Improved by: Improve working capital or reduce unprofitable sales while maintaining working capital

Working Capital

Formula

Current Assets - Current Liabilities

Principal measure of liquidity; Target for working capital should be at least one-half of operating budget

Improved by: Increasing current assets (increase turnaround on accounts receivable), decrease current liabilities (reduce short term debt), increase net income to improve cash flow

Debt and Risk Ratios

Debt Service Coverage

Formula

Income before income taxes + depreciation + amortization + interest / Repayment of debt this year + interest

Measures the ability of the company to generate cash flow to cover long-term obligations

Improve by: Improve profit or reduce long-term debt

Total Debt to Assets

Formula

Total Liabilities (Current Liabilities + Non Current Liabilities) / Total Assets

A measure of the relative obligations of a company; Debt/Asset of greater than 0.5 indicates that equity position by owners is less than 50%

Improve by: Reducing a company's debt load, tighter control of purchases

Total Debt to Net Worth

Formula

Total Liabilities (Current Liabilities + Non Current Liabilities) / Total Net Worth

Meaning: Measure of leverage

Improve by: Improve profit, selling additional capital stock, sell off unproductive assets

Profitability Ratios

Profit Margin

Formula

Profit before tax/ Total Sales

Meaning: Measures operating performance

Improve by: Increase margins, increase service fees, or reduce expenses

Gross Margin

Formula

Gross Profit / Net Sales

Meaning: Measures ...