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There’s only one reason why I continue to hold the majority of my portfolio in US stocks: the reporting and transparency requirements by the SEC rock.

Without them, calculating the below balance sheet ratios would be a nightmare.

The following list of ratios can be applied to both the public and private sector. At Old School Value, we apply these ratios to help discover undervalued stocks to invest in. It makes a big impact by helping you avoid falling knives and value traps.

So, let’s get straight into the 20 balance sheet ratios you need to help you determine the financial health of a company. You will note that most of these balance sheet ratios are basic, which makes them easy to calculate. Simple ratios and ideas are often the best.

At the end of the article, you can download a pdf of the 20 balance sheet ratios.

Now, let’s get started on the balance sheet ratios refresher.

Solvency Ratios

Solvency Ratios are quick and easy to calculate and easy to interpret.

The objective is to see whether a company has enough cash, assets and low debt to continue operations without running into financial trouble.

Quick Ratio

Quick Ratio = (Current Assets – Inventories) / Current Liabilities

The quick ratio measures a company’s ability to meet its short-term obligations with its most liquid assets. The higher the quick ratio, the better the position of the company.

Current Ratio

Current Ratio = Current Assets / Current Liabilities

An even simpler variant to the quick ratio and is used to determine the company’s ability to pay back its short term liabilities. You’ll see this balance sheet ratio everywhere.

If the ratio is below 1, it raises a warning sign as to whether the company is able to pay its short term obligations when due. It doesn’t mean the company will go bankrupt but is something that has to be looked at. If a company has a low current ratio year after year, it could be a characteristic of the industry where companies operate and high debt levels.

Debt/Equity Ratios

Total Debt/Equity Ratio = Total Liabilities / Shareholders Equity

Long Term Debt/Equity Ratio = Long Term Debt / Shareholders Equity

Short Term Debt/Equity Ratio = Short Term Debt / Shareholders Equity

There are different variations of the debt to equity ratios, but the objective of these financial ratios is to determine how a company has been financing its growth.

A high ratio means that the company has been growing due to debt, or leverage. Not all debt is bad, but if the number is exceedingly high, remember that the company has to pay off the loan as well as interest payments.

An important factor to consider then is to determine whether the returns generated from the debt exceeds the cost of debt (i.e. interest).

Activity Ratios

Activity financial ratios measure how well a company is able to convert its assets in the balance sheet into cash or sales. By analyzing the activity ratios, you can see how efficient and well run a company is.

These financial metrics aren’t just for the company, but also measures the people behind the business and how well they are running the show.

Days Sales Outstanding (DSO)

Days Sales Outstanding = (Receivables / Revenue) x 365

Cash is king and a business capable of converting its receivables into cash quickly is a great sign of health and efficiency.

A low DSO number means that it takes a company fewer days to collect its accounts receivable. A high DSO number shows that a company is selling its product to customers on credit and taking longer to collect money.

Days Inventory Outstanding (DIO)

Days Inventory Outstanding = (Inventory / COGS) x 365

This financial ratio is used to measure the average number of days a company holds inventory before selling it.

This ratio is industry-specific and should be used to compare competitors. A company like Boeing will have vastly different DIO than a company like Amazon where inventory turnover is high.

Days Payable Outstanding (DPO)

Days Payable Outstanding = (Accounts Payable / COGS) x 365

Days Payable Outstanding shows the time in days a business has to pay back its creditors. On the flip side, it also shows how long the company can utilize the cash before paying it back.

The longer a company can delay payments, the better.

Cash Conversion Cycle

Cash Conversion Cycle = DIO + DSO – DPO

Putting DIO, DSO and DPO together, you get the cash conversion cycle.

The entire cash conversion cycle is a measure of management effectiveness. The lower the better, and a great way to compare competitors.

For a full explanation as well as company comparisons and examples, check out the article on cash conversion cycle.

Turnover Ratios

Receivables Turnover = Revenue / Average Accounts Receivables

The receivables turnover ratio is one that is categorized as an activity ratio because it measures the company’s effectiveness in collecting its credit sales.

Inventory Turnover = COGS / Average of Inventory

Inventory is money. It costs money to buy, it costs money to just hold it because it takes up a lot of overhead if it isn’t cleared out. You waste shelf space, the product gets old and it may have to be sold at a fraction of the price just to get rid of it.

Inventory turnover is important for companies with physical products and is best used to compare against peers. After all, the inventory turnover for a retailer like Wal-Mart is going to be very different to a car company like Ford.

Average Age of Inventory (Days)

Average Age of Inventory = Average of Inventory / Revenue

The average age of inventory is just the inverse of Inventory Turnover.

I’ve separated the two because it is easier to visualize the inventory age in days. Let’s say that the inventory turnover for Safeway is 10. But it just makes it easier to visualize the inventory when it is described as 36.5 days instead of a turnover ratio of 10.

Intangibles to Book Value Ratio

This balance sheet metric is helpful in checking quality and health.

Unless a company holds a lot of valuable intellectual property or well-known brands, I like to see intangibles kept low. This is a simple balance sheet analysis to show how much of the company’s value is built on intangibles.

Intangibles to Book Value = Intangibles / Book Value

Inventory to Sales Ratio

Inventory to Sales = Inventory / Revenue

A rather simple and less used ratio. It is mostly useful when you track it year over year or every quarter.

The objective is to see how inventory is being managed as it will signal potential problems with cash flow.

An increase in the inventory to sales ratio can indicate that

your investment in inventory is growing more rapidly than sales

or sales are dropping

Vice versa, if the inventory to sales ratio drops, it could mean that

your investment in inventory is shrinking in relation to sales

sales are increasing This is a high level balance sheet ratio but it will point you in the right direction when you need to dive deeper into inventory trends.

Capital Structure Ratios

Capital structure is looking at the company’s debt and equity. The following ratios all help to show you how much a company is using debt to run the business.

These are easy balance sheet ratios to understand and offer a quick check for red flags.

LT-Debt as % of Invested Capital = Long Term Debt / Invested Capital

ST-Debt as % of Invested Capital = Short Term Debt / Invested Capital

where,

Invested Capital = Shareholders Equity + Total Liabilities – Current Liabilities – Excess Cash

Debt to Equity Ratios

Watch how these ratios have trended in order to understand whether the company is in a difficult situation or not. If a company operates on high leverage and has maintained a high debt ratio, it is not as alarming as a company with a low debt ratio suddenly showing a spike in the debt ratio.

LT-Debt to Total Debt = Long Term Debt / Total Debt

The long term debt ratio is an indicator that the company does not have enough cash to run future operations. Look into the deal for the debt, what the interest payments are, what level of operation the company has to achieve in order to remain within the debt covenant.

ST-Debt to Total Debt = Short Term Debt / Total Debt

If the short term debt ratio is high, this is a big warning sign. The debt payment is coming due and has to be re-negotiated or paid off with a new loan.

There are situations where a high short term debt ratio will cause high levels of uncertainty and the stock to sell-off.

Total Liabilities to Total Assets = Total Liabilities / Total Assets

A broad ratio to show the level of liabilities on the balance sheet compared to the assets.

Price to Working Capital = Price / Working Capital per Share

where,

Working Capital = Current Assets – Current Liabilities

Working capital is the absolute lifeblood of a company. Most fast growing and successful businesses die due to a lack of working capital. That’s why most companies went public in the first place; to get more working capital from the public market.

A high working capital ratio shows whether the business can continue to operate without troubles.

For retailers, you would want to subtract inventory from the working capital equation to get a better picture.

Balance Sheet Ratios Download

Download the PDF of the 20 Balance Sheet Ratios to Measure a Company’s Health