Business Financial Formulas

Kilian van Woerkom

Liquidity ratios

Liquidity ratios tells if a company is able to meet its current (short-term/within 12 months) obligations. Therefore the company can evaluate on if they are performing well enough.

* Current ratio is the ability to meet the current obligations/liabilities. If current ratio is 1.58, this means that the company has $1.58 of current assets for every $1 of current liabilities.

* Needed: Balance sheet

Current Ratio= current assetscurrent liabilities

* A more stringent ratio is the acid-test ratio. For this, only “quick assets” (cash and near-cash assets) are used, so inventory and prepaid expenses are excluded (this can take months to convert into money).

* Needed: Balance sheet

Acid˗test quick-testratio= Current assets-inventories-prepaid expenses =quick assetsCurrent liabilities

Or

Acid˗test quick-testratio= Cash+Marketable securities+notes receivable+accounts receivable Current liabilities

* The operating cash flows to current liabilities compares the cash flow of the company to the obligations within 12 months (short-term). If the ratio is 88.2% (.882), this means that (only) $.882 of cash flows from operations was provided for each $1 of current debt.

* Needed: Balance sheet + cash flow statement

Operating cash flow to current liability ratio=Operating cash flowAverage current liabilities

* Accounts receivable turnover measures the speed of the conversion of accounts receivables. The faster it is turned over, the more credibility the current and acid-test ratios get.

* Needed: Balance sheet + Income statement

Account receivable turnover=total revenueAverage account receivable

* The average collection period shows how many days a company takes to collect its account receivable on average.

* Needed: Balance sheet + Income statement

Average collection period=365Accounts receivable turnover

* The working capital shows how much money a company has to its disposal for...