Ratio Analysis Recommendation

How's business? Of course, that's a loaded question. Better questions are: are your co-workers working as efficiently as they should be? How does your company compare to other similar businesses? Could your company survive a "doomsday" scenario? Using financial ratio analysis, you can learn the answers to these questions and more.

Financial ratios are formed when two or more numbers are taken from a financial statement and combined in different ways. Typically, these numbers are taken from the income statement and balance sheet.

Financial ratios are primarily used to gauge the profitability, solvency, and efficiency of a business. Profitability ratios gauge how successfully the company is able to produce a profit. Solvency ratios measure the company's ability to meet financial obligations in a timely manner. Efficiency ratios measure how efficiently the company uses its assets (including people) in generating sales or profits.

Basic Terms

Before we go any further, let's define a few of common terms.

COGS (cost of goods sold): An income statement figure that represents the cost of equipment, materials, subcontractors, labor, and other direct expenses purchased for a specific job.

Expenses (also known as overhead): General and administrative expenses, not including depreciation and amortization.

Accounts receivable: Money owed by customers for goods and services you have provided them (unpaid invoices).

Accounts payable: Money owed to vendors for goods and services that they have provided you (unpaid bills).

Current assets: A balance sheet item which equals the sum of cash, accounts receivable, inventory, prepaid expenses, and other assets that could be easily converted to cash in less than one year.

Current liabilities: A balance sheet item which equals the sum of accounts payable, short term debt, notes payable, taxes payable, withholdings and other liabilities that must be satisfied within one year.

Working capital: Current assets...