Financial Ratios Based on the Balance Sheet

Financial statement analysis includes financial ratios. Here are three financial ratios that are based solely on current asset and current liability amounts appearing on a company's balance sheet: 

Financial Ratio		How to Calculate It	What It Tells You
Working Capital	= = =	Current Assets – Current Liabilities $89,000 – $61,000 $28,000	An indicator of whether the company will be able to meet its current obligations (pay its bills, meet its payroll, make a loan payment, etc.) If a company has current assets exactly equal to current liabilities, it has no working capital. The greater the amount of working capital the more likely it will be able to make its payments on time.
Current Ratio	= = =	Current Assets ÷ Current Liabilities $89,000 ÷ $61,000 1.46	This tells you the relationship of current assets to current liabilities. A ratio of 3:1 is better than 2:1. A 1:1 ratio means there is no working capital.
Quick Ratio (Acid Test Ratio)	= = = =	[(Cash + Temp. Investments + Accounts Receivable) ÷ Current Liabilities] : 1 [($2,100 + $100 + $10,000 + $40,500) ÷ $61,000] : 1 [$52,700 ÷ $61,000] : 1 0.86 : 1	This ratio is similar to the current ratio except that Inventory, Supplies, and Prepaid Expenses are excluded. This indicates the relationship between the amount of assets that can quickly be turned into cash versus the amount of current liabilities.

Four financial ratios relate balance sheet amounts for Accounts Receivable and Inventoryto income statement amounts. To illustrate these financial ratios we will use the following income statement information:

Example Corporation Income Statement For the year ended December 31, 2011 Sales (all on credit) $500,000 Cost of goods sold   380,000 Gross profit   120,000 Operating expenses Selling expenses 35,000 Administrative expenses    45,000 Total operating expenses    80,000 Operating income 40,000 Interest expense    12,000 Income before taxes 28,000 Income tax expense     5,000 Net income after taxes $ 23,000