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Financial Ratios and Meanings

Liquidity Ratios

Current Ratio:

Formula: Current Assets / Current Liabilities

Meaning: Measures the ability to meet current obligations in a timely manner. A healthy

current ratio is greater than 2.

Improve by: Increase current assets by increasing profit, selling additional capital stock,

borrowing additional long term debt, or disposing of unproductive fixed assets and retaining

proceeds. Reduce current liabilities by retaining a greater portion of allocated savings. Avoid

financing non-current assets with current liabilities.

Working Capital to Sales:

Formula: Working Capital (Current Assets minus Current Liabilities) / Total Sales

Meaning: Measures the degree that working capital should meet daily obligations in relation to

business volume

Improved by: Improve working capital or reduce unprofitable sales while maintaining working

capital

Working Capital:

Formula: Current Assets - Current Liabilities

Meaning: Principal measure of liquidity; Target for working capital should be at least one-half

of operating budget

Improved by: Increasing current assets (increase turnaround on accounts receivable), decrease

current liabilities (reduce short term debt), increase net income to improve cash flow

Debt and Risk Ratios

Debt Service Coverage:

Formula: Income before income taxes + depreciation + amortization + interest / Repayment of

debt this year + interest

Meaning: Measures the ability of the company to generate cash flow to cover long-term

obligations

Improve by: Improve profit or reduce long-term debt

Total Debt to Assets:

Formula: Total Liabilities (Current Liabilities + Non Current Liabilities) / Total Assets

Meaning: A measure of the relative obligations of a company; Debt/Asset of greater than 0.5

indicates that equity position by owners is less than 50%

Improve by: Reducing a company’s debt load, tighter control of purchases

Total Debt to Net Worth:

Formula: Total Liabilities (Current Liabilities + Non Current Liabilities) / Total Net Worth

Meaning: Measure of leverage

Improve by: Improve profit, selling additional capital stock, sell off unproductive assets

Profitability Ratios

Financial Ratios And Meanings