CHASE - CREDITCARDS

How to Analyze Your Financial Statements

Financial Ratios

Once you have your financial statements completed, use these ratios to determine the health of your business and to compare to industry norms.

• Current Ratio = Current Assets/Current Liabilities. This ratio measures your liquidity—the ability to meet current obligations with current assets. 
• Debt to Worth = Total Debt/Net Worth. This ratio measures leverage—how much you owe lenders compared to how much of your own money is invested in the business.  
• Gross Profit Margin = Net Sales - Cost of Goods Sold /Net Sales. This ratio measures the profitability of your business.  
• Operating Profit Margin = Operating Profit/Net Sales. This ratio shows how much your business earns on sales—the main cash flow source.  
• Return on Sales = Net Profit After Taxes/Net Sales. This ratio measures overall profitability. 

Talk to your accountant and banker to find out which of these ratios are relevant to your business, and to identify the industry norms.  

Investigating Cash Flow Shortfalls

Inventory and accounts receivable are common areas of cash shortfall. These two areas are ripe for further investigation.

Digging Deeper—Accounts Receivable

To determine whether you are you collecting accounts receivable in a timely fashion, follow the formula below and compare your results with the industry averages.

1. Accounts Receivable (as stated on your Balance Sheet)/Net Sales (as stated in your Income Statement) = Receivables to Sales Ratio.
2. Next, calculate Receivables to Sales Ratio x 365 (days in year) = Average Collection Period. (Number of days)

 EXAMPLE: Accounts Receivable = $27,000 and Net Sales = $175,000

1. $ 27,000 / $175,000 = .15
2. .15 x 365 = 54.75 days (round up to 55 days)

This calculation indicates that your average collection period is 55 days. To know whether you should be concerned, you need to compare it to the industry's norm. If your collection period is long when compared to the industry’s norm, you may need to reduce it to speed up cash inflows. Request your accountant's input for suggestions on ways to improve your collection period.

Digging Deeper—Inventory

You should determine if you have the right levels of inventory. If your levels are too high, you can tie up cash and risk carrying obsolete inventory. Low levels may cause you to lose sales and miss the benefit of buying in quantity. Calculate your Inventory Turnover Rate to help determine the correct levels:

Cost of Goods Sold/Average Inventory =
Inventory Turnover Rate

EXAMPLE:  Cost of Goods Sold is $70,000, beginning inventory is $10,000, and ending inventory is $9,000. Average inventory equals beginning inventory plus ending inventory divided by 2. The inventory turnover in this example equals 7.37 times ($70,000/$9500).

This example shows that the inventory turns over 7.37 times. Discuss these results with your accountant to understand how your business compares with the averages in your industry.

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