Ratios.pdf - ACC 691 Common Ratios Used In Analyzing...

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ACC 691 Common Ratios Used In Analyzing Financial Statements
Liquidity Ratios
Liquidity is a measure of the firm’s ability to pay its short - term liabilities. It is an estimate of the firm’s
viability in the short run. Recall that current assets are those assets expected to pay current liabilities
and that liabilities are not considered current unless they are going to be paid with current assets.
Therefore, liquidity analysis deals with looking at the relationships between current assets and current
liabilities. Typically, the current ratio should be a little over 150% to 200%, the quick ratio should be
around 100%, and the working capital should be positive. These ratios can be too large, in that a current
ratio of 500% indicates that extra capital has not been invested as it should have been.
Liquidity Ratios: Assessing Ability to Pay Short-Term Debts
Current Ratio Current Ratio = Current Assets / Current Liabilities
Quick Ratio or Acid-Test Ratio Quick Ratio = Current Assets – Inventories – Prepaid Assets /
Current Liabilities
Net Working Capital Ratio Net Working Capital Ratio = (Current Assets – Current
Liabilities) / Total Assets
Profitability Ratios
Profitability ratios are intended to help measure the firm’s ability to produce profits by virtue of its
investments and capital acquisition. Return on assets ( ROA ) is as its name implies — the percentage of
earnings on the average assets held during the year. Return on equity (ROE) and return on common
equity (ROCE) are intended to show the amount that the firm has earned on the average capital
generated by sale of stock. Profit margin shows the ratio of net income to net sales, indicating how well