Below is an example of 11 of the most commonly used ratios by financial institutions as they assess the credit worthiness of potential commercial clients. Please provide us with your feedback on the helpfulness of this information. If you have any suggestions on other topics that you might want covered, please reach out with your suggestions.
Current ratio – measures cash reserves; 2 is solid; varies by industry. Calculated by dividing current assets by current liabilities.
Quick ratio – indicates what a company can realize in cash right away; 1 is solid. Calculated by current assets minus inventory divided by current liabilities.
EBITA – indicates underlying financial performance by stripping away non-revenue based factors. Calculated by earnings minus interest, taxes and amortization.
Debt to assets – measures security of current debt; .33 is good. Calculated by dividing long-term debt by total assets.
Debt to equity – provides insight into a company’s financial strategy. Calculated by dividing total debt by total equity.
Leverage – shows how many assets each dollar of equity supports. Calculated by dividing total assets by shareholders equity.
Inventory turnover – measures how much money is tied up in inventory. Calculated by dividing total sales by the total value of inventory.
Average collection period – Use to assess collection policies and procedures; if terms are net 30, then 30 to 40 is good. Calculated by dividing accounts receivable by sales per day.
Sales to fixed assets – show sales efficiency; must be compared to industry average. Calculated by dividing sales to assets.
Profit margin on sales – shows profit efficiency; must be compared to industry average. Calculated by dividing net income to total sales.
Return on equity – shows yield to investors; 15% considered good. Calculated by dividing net income to shareholders equity.
It’s all about the numbers, and they matter but other things come into play as well. We call them the 7 C’s of credit: Character, Collateral, Capacity, Capital, Conditions, Credibility, and Credit history.
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Labrecque Business Consulting
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Qualicum Beach, B.C.