The Werner Ten Key Business Ratios

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The Werner Ten Key Business Ratios

  1. 1. The Werner Ten Key Business Ratios By Jonathan L. Werner
  2. 2. The Werner Ten Key Business Ratios <ul><li>#10) Net Profit ÷ Total Assets </li></ul><ul><li>(Return on Assets) </li></ul>This is a much better profitability measure than Return on Investment (ROI), as ROA better reflects the efficacy of asset management. However, since they both contain profit as part of the equation, they both also contain the inherent volatility of a short-term measure. A better way to view this ratio is as a long-term trending device. Another factor that can skew this ratio is a large investment in fixed assets.
  3. 3. The Werner Ten Key Business Ratios <ul><li>#9) Net Profit ÷ Net Worth </li></ul><ul><li>(Return on Investment) </li></ul>This is another profitability ratio, which is best looked at only occasionally, because it tends to magnify short-term shifts in thinly capitalized companies.
  4. 4. The Werner Ten Key Business Ratios <ul><li>#8) Net Profit ÷ Sales </li></ul>This ratio signifies an overall batting average: This allows managers to identify patterns of consistency over the long haul, not just short-term stardom.
  5. 5. The Werner Ten Key Business Ratios <ul><li>#7) Gross Margin ÷ Sales </li></ul>This test allows for comparison of margins over months with dissimilar sales. Ideally, this ratio remains steady in good months and bad, but it depends on the nature of the business. Fluctuations can be distorted if sales are erratic.
  6. 6. The Werner Ten Key Business Ratios <ul><li>#6) 30 ÷ Inventory Turnover </li></ul>This is another means of monitoring inventory. However, much discretion is needed to properly interpret this ratio, since it can be greatly influenced by inventory ordering patterns.
  7. 7. The Werner Ten Key Business Ratios <ul><li>#5) Cost of Goods Sold ÷ Average Inventory </li></ul>This test measures the efficacy of inventory managed. Since most have a reasonably steady inventory turn, it is necessary to compare figures from year to year in order to determine the cause, magnitude, and significance of fluctuations .
  8. 8. The Werner Ten Key Business Ratios <ul><li>#4) 30 ÷ Receivables Turnover </li></ul>This is another way of looking at receivables, and one that is particularly useful for presenting a graphic representation of the effect of changes in credit and collection operations.
  9. 9. The Werner Ten Key Business Ratios <ul><li>#3) Sales ÷ Receivables </li></ul>This measures the effectiveness of credit and collection policies. If the ratio is going down, collection efforts may be improving, sales may be rising, or receivables are being reduced. If the ratio is going up, sales credit policies may be changing, collection efforts may be flagging, or sales may have taken a nosedive. Caution : This ratio depends on when receivables are measured and the seasonality of the business. Careful bookkeeping is also essential. The same applies to inventory turnover: Make sure that the measures are comparable from month to month. Use average receivables if possible.
  10. 10. The Werner Ten Key Business Ratios <ul><li>#2) Current Assets ÷ Current Liabilities </li></ul>This is another measure of ability to meet current obligations. It is less accurate than #1 for very near term, but probably is a better measure for six months to a year out, since it contains receivables and inventories as well as cash and near cash. The rule of thumb is 2-to-1, though this will be affected by seasonality.
  11. 11. The Werner Ten Key Business Ratios <ul><li>#1) Cash and Near Cash ÷ Current Liabilities </li></ul>This ratio measures the ability to meet current debt. This test is very stringent as it discounts the value of inventories. The rule of thumb is 1-to-1. A lower ratio indicates liquidity issues. A higher ratio may imply unused funds.

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