How to achieve success in life and in your professional life, how to grow, be happy and live longer
1. Analyze your company's overall strategy.
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2. If your company does top-down budgeting, start with the targets given to you by senior management. If your company does bottom-up budgeting, create these targets yourself. What will best meet the needs of your unit? List the 3–5 most important goals for your unit—and put an expected completion date on each of them. |
3. Articulate your assumptions.
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4. Quantify your assumptions.
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5. Take a step back.
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| This kind of analysis is useful when considering an investment that will enable you to sell something new, or to sell more of something you already make. It tells you how much (or how much more) you need to sell in order to pay for the fixed investment—in other words, at what point you will break even. With that information in hand, you can look at market demand and competitors' market shares to determine whether it's realistic to expect to sell that much. In more precise terms, the breakeven calculation helps you determine the volume level at which total contribution from a product line or investment equals total fixed costs. But before you can perform the calculation, you need to understand the components that go into it. Contribution is defined as unit revenue minus variable costs per unit; it's the sum of money available to contribute to paying fixed costs. Fixed costs are items such as insurance, management salaries, rent, product development costs—they're items that stay pretty much the same no matter how many units of a product or service are sold. Variable costs are those expenses that change depending on how many units are produced and sold; examples would include labor, utility costs, and raw materials. With these concepts, we can understand the calculation:
At this point, Amalgamated must decide whether the breakeven volume is achievable: Is it realistic to expect to sell 1,887 additional hat racks, and if so, how quickly? Note that this volume must be incremental: because Amalgamated has been producing this type of hat rack all along, and the extruder simply represents a way to improve the production process, the compensating sales volume must be above and beyond current sales volume. |
| Basically, this means evaluating whether, over a given time frame, the benefits of the new investment, or the new business opportunity, outweigh the associated costs. Before beginning any cost/benefit analysis, it's important to understand the cost of the status quo. You want to weigh the relative merits of each investment against the negative consequences, if any, of not proceeding with the investment. Don't assume that the costs of doing nothing are always high: in many cases, even when significant benefits could be gained from a new investment, the cost of doing nothing is relatively low. Cost/benefit analysis of a particular investment involves the following steps:
Once that's done, you're ready to begin the evaluation phase using one or more of the following analytical tools:
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| As a manager, you are expected to put together a budget for your department each year. Your compensation may depend, to a large extent, on your ability to stick to that budget. So it's in your best interest to create a realistic budget when you start out. Begin by setting goals. An ambitious manager wants to improve her division's performance over the previous year, increase net income for the company, or decrease costs—maybe even all three. How do you think your department can accomplish everything it has set out to do? That's where the budget comes into play. After all, a budget is a plan with numbers. Start with a list of three to five goals that you'd like to achieve—and put a completion date on them, too. For example:
Role-playing may help you here. Put yourself in the position of a division manager with limited resources and many departmental requests for funding. How can you make your case for two additional staff members so that the division manager grants your request ahead of all the others? |
| A budget is a blueprint for achieving specific goals. Your unit's budget is part of your company's overall strategy. So you need to understand your company's strategy in order to create a useful budget. |
How can you familiarize yourself with your company's overall strategy?
If your company does top-down budgeting, senior management sets very specific objectives for such things as net income, profit margins, and expenses. For instance, each department may be told to hold expense increases to no more than 6% above last year's levels. It's left up to you to allocate your budget within the parameters to ensure that the objectives are achieved. For example, suppose Amalgamated Hat Rack decides that it wants to increase overall profitability by 10%. That could mean, among other possibilities, launching a new product line to generate new sales, or cutting overhead by upgrading technology, which would reduce the need for part-time workers. In addition, if your company does top-down budgeting, make sure to look at the overall plans for sales and marketing, as well as cost and expense plans, as you prepare your budget. The company's sales plan determines, to a large extent, how much money will be available for the budget. The marketing budget will give you an idea of what the company will be emphasizing in the coming year. Further, many companies that emphasize quality insist on reducing expenses every year, no matter how slightly, as a way to improve overall company quality. Thus, most major expenses—a new computer system, a new plant, a new field office—are carefully budgeted years in advance. In companies that do bottom-up budgeting, managers aren't given specific targets. Instead, they begin by putting together budgets that they feel will best meet the needs and goals of their respective departments. These budgets are then "rolled up" to create an overall company budget, which is then adjusted, with requests for changes being sent back down to the individual departments. This process can go through multiple iterations. Often it means working closely with other departments that may be competing against yours for limited resources. It's best to be as cooperative as you can with other departments during this process, but that doesn't mean you shouldn't lobby aggressively for your own unit's needs. |
| Beyond profitability, operating, and leverage ratios, other ways of evaluating the financial health of a company include valuation, Economic Value Added (EVA), and assessing growth and productivity. Like the ratios described above, all of these measures are most meaningful when compared against the same measures for other companies in that particular industry. Valuation. Wall Street investors and stock analysts scrutinize a company's financial statements and stock performance carefully in order to arrive at what they believe to be a realistic estimate of that company's value. Since a share of stock denotes ownership of a part of the company, analysts are interested in knowing whether the market price of that share is a good deal relative to the underlying value of the piece of the company the share represents. Wall Street uses various means of valuation, that is, of assessing a company's financial performance in relation to its stock price. The earnings per share (EPS) equals net income divided by the number of shares outstanding. This is one of the most commonly watched indicators of a company's financial performance. If it falls, it will likely take the stock's price down with it. The price-to-earnings ratio (PE) is the current price of a share of stock divided by the previous 12 months' earnings per share. It is a common measure of how cheap or expensive a stock is, relative to earnings. The price-to-book ratio is the current market price of a share of stock divided by a stock's book value per share. (To calculate the book value, subtract the preferred stock total from total equities, then divide the result by the number of shares outstanding.) Growth indicators. Growth measures can tell a great deal about financial health. A company's growth allows it to provide increasing returns to its shareholders, and to provide opportunities for new and existing employees. The number of years over which you should measure growth will depend on the business cycle of the industry the company is in. A one-year growth figure for an oil company—an industry that typically has long business cycles—probably doesn't tell you very much. But a strong one-year growth figure for an Internet company would be significant. Common measures of growth include sales growth, profitability growth, and growth in earnings per share. Economic Value Added (EVA). This concept was introduced as a way to induce employees to think like shareholders and owners. It is the profit left over after the company has met the cost of capital—the expectations of those who provided the capital. (Another way to describe cost of capital is that it is the weighted cost average to the company of acquiring debt and equity financing.) |
Leverage has to do with a company's debt structure: the greater the component of long-term debt in the overall debt structure, the greater the financial leverage. The following measures help you determine whether your company's level of debt is appropriate and assess its ability to pay the interest on its debts.
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By linking various income statement and balance sheet figures, these measures provide an assessment of a company's operating efficiency.
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These measures evaluate a company's level of profitability by expressing sales and profits as a percentage of various other items.
| By themselves, financial statements tell you quite a bit: how much profit the company made, where it spent its money, how large its debts are. But how do you interpret all the numbers these statements provide? For example, is the company's profit large or small? Is the level of debt healthy or not? |
| Ratio analysis provides a means of digging deeper into the information contained in the three financial statements. A financial ratio is two key numbers from a company's financial statements expressed in relation to each other. The ratios that follow in the next posts are relevant across a wide spectrum of industries, but are most meaningful when compared against the same measures for other companies in the same industry. |
The three financial statements offer three different perspectives on your company's financial performance. That is, they tell three different but related stories about how well your company is doing financially.
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| A cash flow statement gives you a peek into a company's checking account. Like a bank statement, it tells how much cash was on hand at the beginning of the period, and how much was on hand at the end of the period. It then describes how the company spent its cash. As with a checkbook, uses of cash are recorded as negative figures, and sources of cash are recorded as positive figures. If you're a manager in a large corporation, changes in the company's cash flow won't typically have an impact on your day-to-day functioning. Nevertheless, it's a good idea to stay up to date with your company's cash flow projections, because they may come into play when you prepare your budget for the upcoming year. For example, if cash is tight, you will probably be asked to be conservative in your spending. Alternatively, if the company is flush with cash, you may have opportunities to make new investments. If you're a manager in a small company, you're probably keenly aware of the firm's cash flow situation, and feel its impact almost every day. The cash flow statement is useful because it shows whether your company is turning profits into cash—and that ability is ultimately what will keep your company solvent. |
| The cash flow statement doesn't measure the same thing as the income statement. If there is no cash transaction, it cannot be reflected on a cash flow statement. Notice, however, that net income on the cash flow statement is the same as the bottom line of the income statement—it's the company's profit. Through a series of adjustments, the cash flow statement translates this net income to a cash basis. In general, a company looks to three sources of cash: ongoing operations, investment activities, and financing activities. It's traditional to start with ongoing operations. Accounts receivable and inventory represent items the company has produced, but hasn't received payment for. Prepaid expenses represent items the company has paid for but has not consumed. These items are all subtracted from cash flow. Accounts payable and accrued expenses represents items the company has already received or used, but hasn't yet paid for. So these items add to cash flow. Investment activities can be
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| Most people go to a doctor once a year to get a checkup—a snapshot of their physical well being at a particular time. Similarly, companies prepare balance sheets as a means of summarizing their financial positions at a given point in time. A balance sheet utilizes double-entry accounting—a system that ensures that each transaction balances. This system relies on the following basic equation: Assets = Liabilities + Owner's Equity. Assets are the things a company invests in so that it can conduct business—examples include financial instruments, land, buildings, equipment, and commodities. In order to acquire necessary assets, a company often borrows money from others or makes promises to pay others. Monies owed to creditors are called liabilities. Owner's equity, also known as shareholders' equity, is what, if anything, is left over after total liabilities are deducted from total assets. Thus, a company that has $3 million in assets and $2 million in liabilities would have owner's equity of $1,000,000.
By contrast, a company with $3 million in assets and $4 million in liabilities would have negative equity of $1 million—and serious problems as well. Thus, the balance sheet "balances" your company's assets and liabilities: the promises and agreements made with customers are balanced against the promises and agreements made with vendors and stockholders. It provides a description of how much, and where, the company has invested (its assets)—broken down into how much of this money comes from creditors (liabilities) and how much comes from stockholders (equity). Moreover, the balance sheet gives you an idea of how efficiently your company is utilizing its assets and how well it is managing its liabilities. Balance sheet data is most helpful when it's compared with information from a previous year. Next, the balance sheet tallies other assets that have value but are tougher to convert to cash—for example, buildings and equipment. These are called plant assets, or, more commonly, fixed assets (because it's hard to move them). Since most fixed assets, except land, depreciate over time, the company must also include accumulated depreciation in this part of the calculation. Gross property, plant, and equipment minus accumulated depreciation equals the current book value of property, plant, and equipment. Here again, the balance sheet makes a distinction between short-term liabilities, also known as current liabilities, and long-term liabilities. Short-term liabilities typically have to be paid in a year or less; they include short-term notes, salaries, income taxes and accounts payable. Subtracting current liabilities from current assets gives you the company's working capital. Working capital gives you an idea of how much money the company has tied up in operating activities. Just how much is adequate for the company depends on the industry and the company's plans. For 1998, Amalgamated had $868,000 in working capital. Long-term liabilities are typically bonds and mortgages. Total assets must equal total liabilities plus owners' equity. Thus, subtracting total liabilities from total assets, the balance sheet arrives at a figure for the owners' equity. Owner's equity comprises retained earnings (net profits that accumulate in a company after any dividends are paid) and contributed capital (capital received in exchange for stock). |
| You might want to invest in a company for many reasons. Perhaps it's a leader in the industry. Or its CEO has a great record of turning companies around. Or its products are on the cutting edge of technology. But if the company is not turning a profit, or doesn't show strong potential to become profitable over the medium term, you probably wouldn't want to invest in it. The income statement tells you if the company is making a profit—that is, whether it has positive or negative net income. (This is why the income statement is also called a profit-and-loss statement.) It shows a company's profitability throughout the year—typically, by presenting monthly, quarterly, and year-to-date summaries of the company's operations. In addition, the income statement tells you how much money the company spends to make that profit—that is, what its profit margins are. How does an income statement present this profitability picture? It starts with a company's revenues: how much money has come in the door from its operations. Various costs—from the costs of making and storing its goods, to depreciation of plant and equipment, to interest and taxes—are then deducted from the revenues. The bottom line—what's left over—is the net income or profit. Consider the following income statement for Amalgamated Hat Rack.
By deducting the cost of goods sold from sales revenues, we get a company's gross margin—the roughest estimation of the company's profitability. Operating expenses include administrative employee salaries, rents, sales and marketing costs, as well as other costs of business not directly attributed to manufacturing a product. The fiberglass for making hat racks would not be included here; the cost of the advertising would. Depreciation is a way of estimating the "consumption" of an asset over time, or of accounting for the diminishing value of equipment as time goes by. A computer, for example, loses about a third of its value each year. Thus, according to the matching principle, the company would not expense the full value of the computer all in the first year of its purchase, but as it is actually used over a span of three years. By subtracting operating expenses and depreciation from gross margin, we get operating earnings—often called earnings before interest and taxes, or EBIT. Interest expense refers to the interest charged on loans a company takes out. Income tax is levied by the government on corporate income. The bottom line—in this case, the net income is positive, thus indicating a profit—is what the for-profit company lives for. |
| Financial statements follow the same general format from company to company. Depending on the nature of the company's business, however, specific line items may vary. Still, the statements are usually similar enough to allow you to compare one business's performance against another's. The reason for this similarity is that accountants abide by Generally Accepted Accounting Principles, or GAAP. Most companies use accrual accounting: Income and expenses are booked when they are incurred, regardless of when they are actually received or paid. This system relies on the matching principle, which helps companies understand the true causes and effects of business activities. Accordingly,
Occasionally, a very small company will begin its existence using cash-basis accounting, which counts transactions when cash actually exchanges hands. This practice is less conservative when it comes to expense recognition, but sometimes more conservative when it comes to revenue recognition. But as companies increase in size and complexity, it becomes more important to match revenues and expenses in the appropriate time periods, so they tend to switch over to accrual accounting. |
| Operating cash flow (OCF). The net movement of funds from the operations side of a business, as opposed to the investment side. OCF is usually described in terms of the sources and uses of cash. When more cash is going out than coming in, there is a negative cash flow; when more cash is coming in than going out, there is a positive cash flow. Operating profit (EBIT). The difference between the revenues of a company and the costs and expenses associated with conducting business. Also known as earnings before interest and taxes. Operating ratios. Financial measures that link various income statement and balance sheet figures to provide an assessment of a company's operating efficiency. Examples of operating ratios include asset turnover, days receivables, days payables, days inventory, current ratio, and quick ratio. Payback period. The length of time needed to recoup the cost of a capital investment; the time that transpires before an investment pays for itself. Pretax profit. Net income before federal income taxes. Price-to-book ratio. A method of valuation for stock, this ratio is calculated by dividing the current market price of a share of stock by the stock's book value per share. Price-to-earnings ratio (P/E). A common measure of how cheap or expensive a stock is, relative to earnings. P/E equals the current price of a share of stock divided by the previous 12 months' earnings per share. Productivity measures. Indicators such as sales-per-employee and net-income-per-employee, which link revenue and profit generation information to work force data, thereby providing a picture of employees' effectiveness in producing sales and income. Profitability ratios. Measures of a company's level of profitability, in which sales and profits are expressed as a percentage of various other items. Examples include return on assets, return on equity, and return on sales. Property, plant, and equipment (PP&E). A line item on a balance sheet that lists the value of a business's land, buildings, machinery, equipment, and natural resources that are used for the purpose of producing products or providing services. Purchase order. A written authorization to a vendor to deliver goods or services at an agreed upon price. When the supplier accepts the purchase order, it is a legally binding purchase contract. Quick ratio. A measure of a company's assets that can be quickly liquidated and used to pay debts. It is sometimes called the acid-test ratio, because it measures a company's ability to deal instantly with its liabilities. To calculate the quick ratio, divide cash, receivables, and marketable securities by current liabilities. Ratio analysis. A means of analyzing the information contained in the three financial statements, a financial ratio is two key numbers from a company's financial statements expressed in relation to each other. Ratios are most meaningful when compared to the same measures for other companies in the same industry. Return on assets (ROA). Expressed as a percentage, ROA is a quantitative description of how well a company has invested in its assets. To calculate it, divide the net income for a given time period by the total assets. The larger the ROA, the better a company is performing. Return on equity (ROE)/return on owner's equity. This measure shows the return on the portion of the company's financing that is provided by owners. It answers the question, "How profitable have management's efforts been?". To calculate ROE, divide the total income by total owners' equity. Return on sales (ROS). Also known as profit margin, ROS is a way to measure a company's operational efficiency—how its sales translate into profit. To calculate ROS, divide net income by the total sales volume. Sales. An exchange of goods and services for money. Sunk costs. Prior investment that cannot be affected by current decisions, and thus should not be factored into the calculation of the profitability of an initiative. SWOT analyses. An analysis of a company's strengths, weaknesses, opportunities, and threats. Time value of money. The principle that a dollar received today is worth more than a dollar received at a given point in the future. Even without the effects of inflation, the dollar received today would be worth more because it could be invested immediately, thereby earning additional revenue. Top-down budgeting. A budgeting process whereby senior management sets very specific objectives for such things as net income, profit margins, and expenses. Unit managers then allocate their budget within these parameters to ensure that the objectives are achieved. Valuation. An estimate of a company's value, usually for the purposes of purchase and sale, or taxation. Leverage ratiosand operating ratios provide means of evaluating and comparing companies' worth. Wall Street uses other ratios that describe a company's financial performance in relation to its stock price: earnings per share (EPS), price-to-earnings ratio (P/E), and price-to-book ratio. Working capital. A measure of a business's ability to pay its financial obligations, working capital equals the difference between a company's current assets (easily sellable goods, cash, and bank deposits) and its current liabilities (debt due in less than a year, interest payments, etc.). Shortages of working capital are often relieved by short-term loans. |
| Hurdle rate. The rate of return on investment dollars required for a project to be worthwhile. It is typically a higher rate of return than what would have been obtained by investing the capital in low- or moderate-risk financial instruments. Income statement. A report that indicates how much profit or loss a company generates over a period of time—a month, a quarter, or a year. In addition, the income statement, sometimes referred to as the earnings statement, tells how much money the company spends to make its profits. Interest coverage. This measures a company's margin of safety, or how many times over the company can make its interest payments. To calculate interest coverage, divide earnings before interest and taxes by the interest expense. Inventory. The supplies of the company that are or will become its product. Examples include the merchandise in a shop, the finished work in a warehouse, work-in-progress, and raw materials. Investment in PP&E. Dollars spent on Property, Plant, and Equipment. Sometimes called capital investment or capital expenditures. Invoice. A bill submitted to the purchaser, listing all items or services, together with amounts for each. Journals. The transaction records of the business. Leverage ratios. Ratios that assess a company's debt structure. The greater the component of long-term debt in a company's overall debt structure, the greater the financial leverage. These ratios, including interest coverage and debt to equity, help determine whether a company's level of debt is appropriate and assess its ability to pay the interest on its debts. Liabilities. The economic claims against a company's resources. Such debts include bank loans, mortgages, and accounts payable. Margin (%). Another term for profit, this equals revenues minus expenses. The margin is often expressed as the percentage by which revenues exceed expenses. Market price appreciation. The increase in the value of an asset over a specified time period. Market value. The value of an asset if it were to be sold at the current market price. Net book value (NBV). The value at which an asset appears on the books of an organization, minus any depreciation (usually as of the date of the last balance sheet) that has been applied since its purchase or its last valuation. Net income. The income of an organization after deducting the expenses, including interest and taxes, incurred in earning that income. Net present value (NPV). The economic value of an investment, calculated by subtracting the cost of the investment from the present value of the investment's future earnings. Because of the time value of money, the investment's future earnings must be discounted in order to be expressed accurately in today's dollars. |
| Earnings per share (EPS). One of the most commonly watched indicators of a company's financial performance, it equals net income divided by the number of shares outstanding. When EPS falls, it usually takes the stock's price down with it. Economic Value Added (EVA). The profit left over after a company has met the cost of capital—the expectations of those who provided of the capital. Equity. The value of a company's assets minus its liabilities. On a balance sheet, equity is referred to as shareholders' equity or owner's equity. Expenditure. An activity that results in an expense, or, the payment of cash for goods or services. This is a more specific term than "disbursement," which can include payments other than cash. Financial leverage. A company's long-term debt in relation to its capital structure (the total of its common stock, preferred stock, long-term debt, and retained earnings). A company that has consistently high earnings can afford to be more leveraged, that is, it can afford to carry more long-term debt than a company whose earnings fluctuate significantly. Financial statements. Reports of a company's financial performance. The three basic types of statement included in an annual report—the income statement, the balance sheet, and the cash flow statement—present related information, but provide different perspectives on a company's performance. Fiscal Periods. An accounting time period (month, quarter, year), at the end of which the books are closed and profit or loss is determined. Fixed vs. variable costs. Fixed costs remain constant despite sales volume; they include interest expense, rent, depreciation, and insurance expenses. Variable costs are incurred in relation to sales volume; examples include the cost of materials and sales commissions. General ledger. A company's centralized and authoritative accounting record, where balance sheet, income, and expense information for the period in question is summarized. Generally accepted accounting principles (GAAP). The rules and conventions that accountants follow in recording and summarizing transactions and preparing financial statements. Gross margin. A ratio that measures the percentage of gross profit relative to sales revenue. Gross profit. The sum left over after all direct product expenses or costs of goods sold have been subtracted from revenues. Growth. An increase in the value of a company's revenues, profits, or the value of its equity. Growth indicators. Measures that tell about a company's financial health. Common measures of growth include sales growth, profitability growth, and growth in earnings per share. |
| Days inventory. A measure of how long it takes a company to sell the average amount of inventory on hand during a given period of time. The longer it takes to sell the inventory, the greater the likelihood that it will not be sold at full value—and the greater the sum of cash that gets tied up. To calculate days inventory, divide the average amount of inventory on hand for the period by the cost of goods sold for the same period, then multiply that quotient by 365. Days payables. A measure that tells how many days—based on balance sheet and income statement data—it actually takes a company to pay its suppliers. The fewer the days it takes, the less likely the company is to default on its obligations. To calculate days payables, divide accounts payable by the cost of goods sold for the period in question, then multiply that quotient by 365. Days receivables. A measure that tells you in concrete terms—based on balance sheet and income statement data—how long it actually takes a company to collect what it is owed. A company that takes 45 days to collect its receivables will need significantly more working capital than one that takes four days to collect. To calculate days receivables, divide net accounts receivable for the given time period by net sales, then multiply that quotient by 365. Debt. What is owed to a creditor or supplier. Debt is sometimes referred to as notes payable or bonds payable. Debt to equity. This measure provides a description of how well the company is making use of borrowed money to enhance the return on owner's equity. To calculate the debt-to-equity ratio, divide total debt (long-term debt plus short-term debt plus current maturities) by total shareholders' equity. Depreciation. A way of accounting for the diminishing value of an asset as time goes by. Direct vs. indirect costs. Costs that are directly attributable to the manufacture of a product—for example, the cost of plastic for a bottling company. Direct costs vary in direct proportion to the number of units produced. Indirect costs cannot be directly attributed to a particular product—for example, the cost of machines that are used in the production of more than one product. Dividend. A payment (usually occurring quarterly) to the stockholders of a company, as a return on their investment. |
| Capital expenditure/capital investment. The payment required to acquire or improve a capital asset. Cash-basis accounting. An accounting process that records transactions when cash actually exchanges hands. This practice is less conservative than accrual accounting when it comes to expense recognition, but sometimes more conservative when it comes to revenue recognition. Cash flow statement. A review of a company's use of cash, this statement tells where the company's money comes from, and where it goes—in other words, the flow of cash in, through, and out of the company. Cash utilization/cash flow measure. The changes that affect a cash account during an accounting period. Chart of accounts. A way to outline the accounting system of a business, the chart of accounts establishes how the business will operate, what information will be captured, and what information will subsequently be readily retrievable by the system. It includes such items as inventory, fixed assets, accounts receivable, and costs. Cost of capital. The costs of different types of capital, including short-term debt, long-term debt, and equity. This cost is typically expressed as a percentage of the underlying capital. Cost of goods sold (COGS). The total cost paid for the products sold during the accounting period, plus freight-in costs. Most small retail and wholesale businesses compute cost of goods sold by adding the value of the goods purchased during the accounting period to the value of the beginning inventory, and then subtracting from that figure the value of the inventory on hand at the end of the accounting period. For manufacturers, cost of goods sold includes, in addition to raw materials, the direct cost of manufacturing labor (including Social Security and unemployment taxes on factory employees), and overhead charges such as supervision, power, and supplies. Cost of services (COS). Charges billed to a customer for a service. Overhead is often included in the calculation of the cost of services. Costs and expenses. The costs related to running the business—for example, salaries, office overhead, light, heat, legal and accounting services. Current assets. Those assets that are most easily converted into cash: cash on hand, accounts receivable, and inventory. Current ratio. This is a prime measure of how solvent a company is. It's so popular with lenders that it's sometimes called the banker's ratio. Generally speaking, the higher the ratio, the better financial condition a company is in. A company that has $3.2 million in current assets and $1.2 million in current liabilities would have a current ratio of 2.7 to 1. That company would be generally healthier than one with a current ratio of 2.2 to 1. To calculate the current ratio, divide total current assets by total current liabilities. |