Year end is just about here. You know what that means, right? It is a great time to settle in by a roaring fire and catch up on reading … your company’s financial statements. One chapter worth a careful perusal is the balance sheet. Therein may lie some important lessons.
Three ratios to consider
In a nutshell, a balance sheet summarizes a company’s assets, liabilities, and shareholders’ equity at a specific point in time. Its objective: To provide an accurate snapshot of the financial standing of the business.
Yet a balance sheet can do so much more. There are a number of ratios you can draw from this report, which can help you lay out strategic plans for next year. Here are three to consider:
- The ratio of current assets to current liabilities. If this ratio falls below one, the company may struggle to pay bills coming due. Some business experts believe a current ratio of less than 2:1 is problematic, but the ideal ratio varies from industry to industry.
- Growth in accounts receivable compared to growth in sales. If receivables are growing faster than increases in sales, your company might be building up bad debts or you could be selling to large customers under disadvantageous terms. You may even be the victim of fraud. (Note: Sales are expressed on your income statement, so you will need to look at that statement as well.)
- Growth in inventory vs. growth in sales. When inventory levels increase at a faster rate than sales, a business is producing products faster than they are being sold. Or, in the retail industry, a company may be overbuying — an inefficient use of working capital. There can be many mitigating circumstances, however, so it is critical to determine exactly what is going on.
These are just a few things you can learn from your balance sheet. In addition, we have not even gotten into the thrilling tales lying within your income statement and statement of cash flow; the other two parts of your financial statements. Please contact our firm for help making the most of this important information.