Check Ratios! Keeping a Bankable Balance Sheet

Achieving and sustaining a bankable balance sheet is very important for the borrowing organizations, attracting investors or for expected long-run solvency. Banks prefer to work with strong balance sheets that prove a concern’s short-term and long term liabilities or financial solvency and long-term revenue generation capability and profitability. I will provide you with an overview of important financial ratios that need to be periodically calculated to maintain your balance sheets optimal performance.

Efficiency ratios

1. Inventory Turnover Ratio

A measure of how often stock is sold and restocked within a particular period.

• Formula: Based on the average inventory, the company was able to sell the Cost of Goods Sold at a reasonable price through the calculation (COGS/AI).
• Why It’s Important: Inventory turnover ratio is therefore a key performance indicator of accounts receivable; a higher ratio showing good stock management while a low ratio may show poor handling of stock or low sales.
• Healthy Ratio: It is averaged out by industry, and industries that rate between 5-10 are said to be good.

2. Asset Turnover Ratio

Illustrates how well a firm utilizes assets to generate its revenues.

• Formula: Total Net Sales / Average Total Asset
• Why It’s Important: A higher ratio of asset turnover means that the company’s assets are being effectively employed to generate sales and vice versa.
• Healthy Ratio: Overall the accuracy of |1.0 is fine, but depends with the industry.

3. Accounts Receivable Turnover Ratio is the denominator which divides to the Receivables figure.

Shows the speed at which a firm recovers credit sales and is an index of efficiency of collection.

• Formula: Net credit sales / Mean account receivable
• Why It’s Important: Receivable turnover ratio measures how fast the company collects its accounts receivables; a high turnover ratio is considered better than a low one because the company might have problems in collecting its receivables.
• Healthy Ratio: 5-10 is considered as reasonable in most industries.

Liquidity Ratio

1. Current Ratio: Measure Liquidity

Current ratio is an essential measure of a company’s capacity to meet its current obligations through its current assets. A high current ratio demonstrates good solvency, and means that your business is capable of handling its near-term responsibilities, which provides needed assurance to creditors and investors alike.

• Formula: Current Assets ÷ Current Liabilities
• Healthy Range: 1.5 to 2.0
• Why It’s Important: A current ratio of over 1.0 means that your business has more assets than it has liabilities and therefore can afford to pay its bills in the short-run.

2. Quick Ratio: The last being the Acid Test of Financial Health.

It is calculated in a way that is more conservative than the current ratio, and that is, it does not count inventory as an asset. It is a good indication of just how accessible a company’s more liquid forms of assets are when it comes to meeting its short-term obligations.

• Formula: While it is widely used as a liquidity ratio, it has the following formula; (Current Assets – Stock) / Current Liabilities
• Healthy Range: Above 1.0
• Why It’s Important: This ratio measures the ability of the company to overcome exigent circumstances involving cash requirements, and, therefore, the financial stability ratio.

Solvency Ratio

1. Debt-to-Equity Ratio: Balance Leverage

This ratio is the established relationship between one business’s debt and its equity. Excessive debt makes it difficult for a company to get additional capital and putting too much emphasis on interests while little leverage may point at lack of expansion goals.

• Formula: Total Liabilities: Shareholder’s Equity
• Healthy Range: 0.5 to 1.5
• Why It’s Important: The amount of debt should thus be manageable as it measures financial discipline and turnaround reduces the odds of the borrower causing a default anathema to a bankable balance sheet.

2. Interest Coverage Ratio: Debt Servicing Ability

This ratio indicates how many times a firm can readily cover the interest payment on outstanding obligation through its EBIT. Low interest coverage means the distress of a firm’s financial position and high possibility of being rejected by financiers.

• Formula: EBIT / Interest Expenses
• Healthy Range: Above 3.0
• Why It’s Important: A high ratio indicate that a business is able to generate adequate profit in order to meet it interests in a proper manner.

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Profitability Ratios

1. Return on Assets (ROA): Profitability of Assets

Analysed return on assets (ROA) can be defined as the extent to which available assets are being profitably utilised. Lenders and investors always look at business organizations which have high returns on assets since they believe that the business organization has operated efficiently by managing its assets well.

• Formula: Net Income / Total Assets
• Healthy Range: Above 5%
• Why It’s Important: A higher ROA implies that your business is utilizing resources in the most efficient way possible to generate revenue and this is good news for investors as well as financial institutions.

2. Return on Equity (ROE): Shareholder Value

ROE is defined as how effectively a business utilises his shareholders’ equity to generate returns. The operating cash flow is very vital in analyzing financial performance as well as the efficiency of management.

• Formula: NI / SE
• Healthy Range: Above 15%
• Why It’s Important: A high ROE shows that the firm is earning a good return on the investments of its shareholders and therefore should be able to attract more investment and financing.

3. Operating Cash Flow Ratio: Cash-Flow Strength

This ratio shows the ability of the business to use Operating cash flow, for payment of its operating expenses. We can learn from this that it is simply an excellent measure of current and operational liquidity.

• Formula: Operating Cash Flow/ Current Liabilities
• Healthy Range: Above 1.0
• Why It’s Important: This implies that the company must be generating enough operational cash flow to meet its short-term obligations, a core value when it comes to bankability of balance sheet.

Why These Ratios Matter

Currently, the following ratios make up the key performances figures in that they give lenders and investors an insight of the company’s financial health, liquidity, profitability and risk profile. It is advisable not to let the situation with these ratios worsen and, with their constant monitoring, avoid liquidity problems, reduce the interest rate, and expand the investments’ list. Evaluating the prospects of your company through sound figures show that your business enterprise would remain creditworthy or bankable in the future.

Conclusion

Thus to achieve and sustain a working bankable balance sheet on the side of the liabilities and on the other side of the assets one needs to be very keen to balance all these factors. Through tracking these scores for your business regularly, your business will always be in good financial health, attract investors and get better rates on financing. Thus, sound financial position is not only about net income, but more about company’s capacity to be financially sound for the foreseeable future.

DISCLAIMER: The information provided in this article is intended for general informational purposes only and is based on the latest guidelines and regulations. While we strive to ensure the accuracy and completeness of the information, it may not reflect the most current legal or regulatory changes. Taxpayers are advised to consult with a qualified tax professional or you may contact to our tax advisor team through call +91-9871990777 or info@semantictaxgen.in