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Recent Banking ArticlesAre Your Business Ratios Convincing Your Banker?
http://www.clean4profit.comThere are several key ratios you need to understand in order to gain your bankers confidence and prove to him/her you know what you are doing. It is much better to prepare and present the information well in advance rather then make the banker ask for it.
The key ratios your banker will be looking for fall into five groups:
· liquidity ratios (are current assets adequate to meet current obligations?),
· coverage ratios (is your business able to service debt?),
· Leverage ratios (how vulnerable is your business to poor market conditions?),
· Operating ratios (these assist you and your banker in evaluating your performance),
· expense to sales ratios.
These ratios can also be expressed in terms of key income statement ratios, key balance sheet ratios and key asset management ratios.
Key balance sheet ratios (ratios based on information from your balance sheet) help the banker (and you) determine the solvency of your business and its financial safety. These ratios include the current ratio, the quick ratio and the safety ratio.
It is the Key asset management ratios, which will help you and your banker, determine how well you are operating your business. These ratios include sales to assets, return on assets, return on equity, inventory management, accounts receivable, management (how quickly you collect your money) and accounts payable management. Unless you are familiar with bookkeeping, it is strongly recommended that you seek assistance from your bookkeeper or accountant before attempting to prepare ratio analysis information for the banker.
Once your bookkeeper or accountant has prepared the ratio information for the loan officer, that individual should consult a copy of the current RMA Annual Statement Studies (Robert Morris Associates, the national association of bank loan officers). Turn to the (SIC) Standard Industrial Code Classification for your industry and start making comparisons between your business and those of your peers. Since there is a significant difference in total sales, costs of operations and so forth, the basis for comparative analysis are these ratios. For more information on how this process works it is recommended you read the relevant information regarding how RMA studies are prepared and what they mean. Your banker and local libraries will have a copy you can review.
In order to give you as clear an understanding as possible, the following key ratio information is based on the RMA material.
Key liquidity ration include the current ratio, the quick ratio, (also known as the “acid test”), sales to receivables, cost of sales to inventory, cost of sales to payable, days payable, and sales to working capital.
Current Ratio
Total current assets
Total current liabilities.
The current ratio divides total current assets by total current liabilities. RMA defines this ratio as a rough indication of a business’s ability to service its current obligations. The higher the current ratio the greater the difference between obligations and your business’s ability to pay them.
Since the current ratio is comparing the current assets with the current obligations of the business, a higher than industry ratio would indicate a larger amount of current assets (cash, inventory, receivables) to current liabilities (payables-including current payroll obligations, and current portion of long term debt) and possibly indicates a stronger position of the business to meet short term obligations.
Quick Ratio
Cash & equivalents + trade receivables – (net)
Total current liabilities
The quick ratio is a more conservative measure of liquidity. This ratio states the degree to which a business’s current liabilities are covered by the most liquid of the assets.
Much like the current ratio, the quick ratio includes only those assets, which can be quickly converted to cash. A higher than average ratio would indicate that quick assets (cash and receivables) are strong in relation to current liabilities for the same reasons as noted above under current ratio. This ratio does not take into consideration the revolving nature of current assets and liabilities, and management can put pressure on either of these to influence this ratio at a particular assessment date.
Sales/Receivable Ratio
Net sales
Trade receivables – net
The sales to receivables ratio is simply set sales divided by trade receivables, and it measures the number of times trade (accounts) receivables turn over during the year. Generally, the higher the turnover, the better.
A higher than average number would be an indication that receivables are lower than usual at the balance sheet date. This could happen if a large outstanding balance was paid off just before the balance sheet date, or could just be that a business’s credit policy is tighter than the average.
Day’s Receivable Ratio
365
sales to receivable ratio
This ratio states the average time in days that receivables are outstanding. As you know, the greater number of days outstanding, the greater the likelihood the accounts receivable will turn bad.
This ratio indicates the average number of days to collect receivables. This can very for the same reasons noted under sales/receivable ratio.
In subsequent articles we will discuss ratios in more detail, including:
· Cost of sales/inventory ratio & day’s inventory
· Cost of sales/Payable ratio
· Sales to Working Capital Ratio
· Coverage Ratios
· Net profit + Depreciation/current portion of long-term debt ratio
· Leverage ratios
· Net fixed assets/net worth ratio
· Debt/net worth ratio
· Operating Ratios
· Percent of profit before taxes/tangible net worth ratio
· Percent of profits before taxes/total assets ratio
· Leverage ratios
· Net fixed assets/net worth ratio
· Debt/net worth ratio
· Sales/net fixed assets ratio
· Sales/total assets ratio
Happy trails
Author:
Donald YatesAbout the Author:Donald Yates, author, Former Director of Leadership and Development Training for First Baptist Church of Crossville, and Business Development coordinator for Imperial Research , is now retired but continues to engage life through self discovery.
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