Financial ratio analysis can serve as an early warning system by measuring a company's performance across key financial metrics. Ratio analysis assumes accurate accounting information and compares a company's ratios to industry standards. Conducting regular ratio analysis can improve a company's profitability and chances of survival by identifying areas for improvement. Key ratios to examine include current assets to current liabilities, accounts receivable to working capital, inventory turnover, net profit to net worth, and net sales to working capital. Comparing ratios to competitors helps pinpoint where a company can enhance efficiency.

1. Financial Ratio Analysis Dennis L. Thompson, CPA

3. The Meaningful Interpretation of Financial Statements – Donald E. Miller Nine Ratios that Measure Effect Current Assets/Current Liabilities Current Liabilities/Net Worth Total Liabilities/Net Worth Inventory/Working Capital Accounts Receivable/Working Capital Long Term Liabilities/Working Capital Net Profit/Net Worth Net Sales/Fixed Assets Net Sales/Working Capital Six Causal Ratios Fixed Assets/Net Worth Days Sales in Accounts Receivable Accounts Receivable/(Credit Sales/360) Net Sales/Inventory Net Sales/Net Worth Net Profit/Net Sales Misc Assets/Net Worth

4. Fixed Assets/Net Worth Measures extent that Net Worth consists of long term, non current assets. Can have negative impact on Working Capital and Current Ratio. Might be increasing Fixed Costs through borrowing. Might be distorted by low Net Worth

5. Accounts Receivable/(Credit Sales/360)- Collection Period Measures efficiency of Company receivable collections. Early warning system for delinquent accounts. Important to measure against Industry competitors. Need to subtract cash sales to arrive at net Credit Sales. Low number can be indicative of restrictive Credit Policy, thus reducing profit.

6. Net Sales/Inventory=Number of Times Measures how quickly Inventory is turning over. Low turnover indicates potential writeoffs. Also could indicate potential shrinkage. Could adversely impact Cash Flow. However, with Inventory management, need to seek a balance of too much and not enough.

7. Net Sales/Net Worth Measures extent Company’s sales are supported by invested capital. High ratio can mean that Company is supporting sales through debt, i.e., Fixed Costs. Can negatively impact Break-Even point. Can increase chances of Company failure because of Fixed Costs. Over emphasis on sales can lead to selling to marginal customers.

8. Net Profit/Net Sales Impacts all the other ratios. Profits add to Net Worth Losses increase the need for Long Term Borrowing, which can impact Working Capital. Losses threaten Company’s ability to survive.

9. Misc Assets/Net Worth Examples : Loans to Employees Prepaid Expenses Usually not a significant part of Balance Sheet. Don’t want to tie up much Captal in these type of assets.

10. Current Assets/Current Liabilities Standard used to be 2:1 Working Capital = Current Assets-Current Liabilities. Problem with Current Assets Includes Inventory Includes Receivables

11. Summary Financial Ratio Analysis can serve as an early warning system. Ratio Analysis assumes that Accounting information is accurate. Improve your Company’s chances for improved Profitability or even Survival by conducting Ratio Analysis. Especially important to compare your Company to Industry Standard Ratios.