Balance sheet ratios

Question 1

What are the two types of Financial Leverage Ratios?

Answer 1

Liquidity ratios

Solvency ratios

Question 2

What are the two most common liquidity ratios?

Answer 2

Current Ratio

Quick Ratio (aka Acid Test Ratio)

Question 3

What is the current ratio?

Answer 3

Current ratio = Current Assets / Current Liabilities

Current assets = Cash; Accounts Receivable; Inventory; Prepaid expenses

Rule of thumb: Current ratio of 2:1 is generally a good sign, but depends on industry

Question 4

What is the Quick Ratio (aka acid test ratio)?

Answer 4

(Current assets - Inventory) / Current Liabilities

So, same as Current Ratio except it excludes inventory, so is more conservative measure of liquidity. Recognizes that inventory many times can’t be easily converted to cash.

Generic rule of thumb is 1:1

Best practice is to calculate both Current Ratio and Quick Ratio and then compare the two. Shows how much of current assets is tied up in inventory. Then can determine how risky that is.

Question 5

What is the Asset Turnover Ratio

Answer 5

Sales / Total (or net) assets

How efficient is the company in using assets to generate revenue? Higher # means more efficiently run. Less capital required to generate revenue.

For every $1 of assets, how many dollars of revenue does the company generate?

Requires # from both Income Statement and Balance Sheet.