Balance Sheet Ratios

Balance Sheet Ratios

1. Current or Working Capital Ratio: (Test of Liquidity)

*C.R = Current Assets/ Current Liabilities

Since C.A are expected to be converted in to cash with in the normal period and since C.L are satisfied by use of C.A. The C.A generally considered being an indicator of the ability of the business to pay its current debts promptly.

C.R is also a measure of the liquidity of the business. And also to determine the solvency of the business enterprise, that is the probable ability of the business to meet its debts promptly & with out loss.

Satisfactory Current Ratio

The ultimate results of all factors is that the financial analysts usually accept that an organization have its C.L covered at least twice by C.A. Thus a minimum 2 to 1 (2:1) C.R is often referred as a ‘rule of thumb’. Standard of liquidity of business, especially from the point of view of short term creditors such as bankers.

Factors affecting Current Ratio

1. The ability of the business to convert debtors, Bills Receivables & stock in to cash determines the extent of C.R. 1 to 1 (1:1) C.R is sufficient in business enterprise in which there is quick stock turnover & collection of debtors because in that case the requirement of working capital would be low. On the other hand a business engaged in the prolonged manufacturing process requires more working capital & hence a high C.R.
2. Seasonal fluctuations also have considerable impact on the C.R. A larger amount of working capital is needed in the peak season when there are heavy purchases of raw materials &production is in full swing. The liabilities may be assumed. As goods are sold, the stock of goods is replaced debtors & B. Receivables. While cash is diminished by the expenses of operation. The cycle is completed when the repayment of Liabilities.

Window Dressing:

For keeping C.R. at a satisfactory level the enterprises uses manipulation or malpractice. It is commonly known as Window Dressing. One of the most common devices used to enhance C.R. is to avoid purchase of goods just before the closing of the books of accounts. The Balance sheet also window Dressed by sale of Fixed Assets, Sale of Debentures.

3. Liquid, Quick or Acid Test Ratio:

= *Quick Assets-(stock +prepaid Exp.) / C.L–(Bank over Draft)

Satisfactory Level:

It indicates a satisfactory liquidity position for the simple reason that the ratio is more than the required yardstick of 1 to 1 (1:1). It may be emphasized that sometimes the investors are more liquid than the debtors & B. Receivables, especially under condition of scarcity.

Balance sheet Ratios Regarding Long Term Position:

1. Proprietary Ratio (Equity – Asset Ratio/ Net worth – Total Asset Ratio (Test of Solvency)

= *Total Shareholders Equity / Total Assets

The ratio should probably be expressed in percentage which can never exceed 100% & it would at the most equal to 100 when there are out side liabilities.

The ratio is of particularly importance of the investors because the presence of a high performance of shareholders fund indicates that there is relatively little danger of winding up or forced reorganization in the event of default in payments to outside liabilities.

Satisfactory Level:

A low proprietary ratio indicates that in the event of financial difficulties the sharejolders may receive little if any of their original investment.

Then the higher proprietary ratio des not it self show that the business is sound. An equity ratio of say 80% or 100% would not necessarily good because sometimes funds from outsiders can be used to the long run advantage of the business enterprises.

2. Asset Proprietorship Ratio:

i. Fixed Asset to Proprietors Fund

ii. C.A to Proprietors fund

F.A to P.F : It expresses the relation of the F.A with funds contributed by the owners or shareholders. In this there are no fictitious assets.

F.A/P.F*100

If the ratio is unduly high the enterprise may be handicapped as 100 much capital is not circulating but it is locked up in F.A.

C.A to P.F: This ratio designed to express the percentage of the amount invested in the C.A to the total funds of the Proprietors.

Total C.A / Total P.F *100