Business Ratioshttp://www.newlearner.com/courses/hts/baf3m/baccl314b.htm#Current%20Ratio

IntroLet's analyze the general utility behind all of these ratios.

What is the first thing you do when you get a test result back?

Chances are you figure out what percent you got on that test.

ExampleWhat does this mean?

72/90

SolutionWithout doing the math, do you know EXACTLY what you’re looking at??

Your mind longs to reduce it to some form of common value, so that you can accurately compare it to every other test that you have ever taken in any subject before.

So what do you do? Well, you figure out the percentage you scored on this

test... which is: 80%

Eureka!Now you know EXACTLY how you feel about the test!

Are you pleased/displeased?? You can now compare it to all other tests.

This is the idea behind all ratios! Accountants have created many methods to use in order to reduce financial aspects of business to common values to be compared.

The Debt RatioTotal debts as a percentage of our total assets.

A large business with a lot of expensive assets can look to be very successful, BUT if a large percentage of those assets were purchased on borrowed funds, then it isn’t necessarily successful.

Equity Ratio = Total Liabilities -------------------------- Total Assets

The Debt Ratio: Value of Homes

Friend "A" may live in a $500,000.00 house, but they still owe $450,000.00 on that house.

Friend "B" may live in a $250,000.00, yet they only owe $50,000.00 on it.

Friend "B" may appear to be less successful, but financial analyses would reveal that they are in fact far MORE successful than friend "A".

After all, friend "A" only has 50,000.00 (10%) worth of equity in their house, while friend "B" has $200,000.00 (80%) worth of equity in their home.

The Debt Ratio: Example

Company A

Assets: $10,000.00 Liabilities: $2,000.00 Equity: $8,000.00 Debt Ratio = $2,000.00 = 20%

----------------- $10,000.00

This is a pretty low debt ratio. Company A only owes 20 cents on every dollar of assets which they own.

The Debt Ratio Company B

Assets: $1,000,000.00 Liabilities:$400,000.00 Equity: $600,000.00 Debt Ratio = $400,000.00 = 40%

--------------------- $1,000,000.00

This is still an acceptable debt ratio. However, despite the massive differences between these two companies we can clearly see that this company's debt situation is twice as bad as the first company's - as Company B owes 40 cents on every dollar of assets which they own.

The Equity RatioShows us what the Owner's Equity is as a percentage of the total Assets.

Equity Ratio = Total Equity ---------------------- Total Assets

The Equity Ratio:Example

Company A

Assets: $10,000Liabilities: $2,000Equity: $8,000Equity Ratio= $8,000 = 80%

-------------$10,000

This is a pretty good equity ratio. Company A has 80 cents of equity in every dollar of assets which they own.

The Equity Ratio:Example

Company B

Assets: $1,000,000.00 Liabilities: $400,000.00 Equity: $600,000.00 Equity Ratio = $600,000.00 = 60%

----------------------- $1,000,000.00

This is still an acceptable equity ratio. However, despite the massive differences between these two companies we can clearly see that this company's equity situation is 20% lower than Company A's - as Company B has only 60% equity in every dollar of assets which they own.

Other Ratios…

Ratio Handout

Find:Debt RatioEquity RatioCurrent RatioQuick RatioReturn on Net SalesReturn on Owner’s Equity