Learning Outcomes
- Perform a ratio analysis on a financial statement
Ratio analysis can be used in a variety of ways to glean information about the financial health of a business.
Here’s a quick introduction to the types of ratios that can be calculated and the value of ratio analysis:
Ok, so ratios are another amazing way to notice variances in assets, liabilities, income and expenses. There are tons of different ratios we could look at but let’s take a couple and examine them for Simply Yoga. Take a look at their balance sheet.
Current Assets: | |
Cash | 9550 |
Accounts Receivable | 900 |
Prepaid Expenses | 1100 |
Total Current Assets | 11550 |
Property and Equipment: | |
Yoga Props (less accum depr) | 1500 |
Total property and Equip. | 1500 |
Total Assets | 13050 |
Current Liabilities: | |
Accounts Payable | 710 |
Payroll Taes Payable | 672 |
Payroll Taxes Payable | 1382 |
Total Current Liabilities | |
Long Term Liabilities | |
Loan Payable | 6500 |
Stockholder’s Equity | |
Common Stock | 1000 |
Retained Earnings | 4186 |
Total Equity | 5168 |
Total Liabilities | 13050 |
Let’s talk first about the working capital ratio. The formula is:
Working capital= current assets−current liabilities
$10,168=$11,550−$1382
So, this shows that Simply Yoga has plenty of funds to pay current liabilities, which is a good thing! But, it also shows that they are holding more funds in a very liquid account, which may be better used to pay off any higher interest debt, such as their loan payable. This is an area for review, right?
The current ratio is another way to look at the ability of a company to cover short term debt.
Current Ratio = Current assets/Current Liabilities
8.36=$11,550/$1,382
What this tells us is that Simply Yoga has enough current assets to cover their current liabilities 8.36 times. Again, this is a good thing, unless they are paying a crazy amount of interest somewhere else. Might that cash be better used to pay off that loan they have sitting on the books?
Learn More
There are tons of ratios out there, that depending on the company and what you are looking for, may be helpful! Check out this great resource for ratio analysis. More ratio formulas can be found here. These ratios may come in handy, so go ahead and print out the list!
You can also check out this video showing the calculation of many liquidity and turnover ratios, or this video showing the calculation of many long-term debt paying ability, profitability, and stock market performance ratios.
What might be some other ratios you would consider for Simply Yoga from the list?
Practice Questions