Balance Sheet Ratios

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Balance sheet ratios are formulas that are used to evaluate the finances of a company or a firm based on the balance sheet report produced by that company. The balance sheet ratio shows the relationship between two items on the balance sheet. It produces a clear analysis of the balance sheet items to determine a company’s results on a quantitative basis.

This method is used to evaluate a company's financial health by computing ratios generated from the balance sheets. The derived ratios are used to produce an extensive and complete picture of how a company manages its money. With this information at hand, modifications can be made by a business owner on how a company should operate to increase profitability and ensure financial security.

Some of the key balance sheet ratios are as follows.

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Current ratio: This method evaluates a company's financial health by computing ratios generated from balance sheets. The formula used for the calculation of the ratio is as follows:
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\(Current~ratio~=~Current~assets~/~Current~liabilities\)
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Current assets can be described as those that can be converted into cash, and current liabilities are those that are payable in a year, such as payments to creditors.

Quick ratio: A quick ratio denotes a company's ability to pay its current creditors in less than a month or immediately. As a result, a quick ratio is calculated by dividing liquid assets (QCA) by current liabilities:

\(Quick~ratio~=~Liquid~assets~/~Current~liabilities\)

Liquid assets refer to those assets that can be changed into cash in a very short period. All current assets except for prepaid expenses and stock are incorporated into liquid assets.

Debt-to-equity ratio: This ratio describes the relationship between extended debts and shareholders' capital. It depicts the proportion of funds gained through long-term borrowings vs the cash collected from shareholders:

\(Debt-equity~ratio~=~Long-term~loans~/~Shareholders'~fund\)

Total assets-to-debt ratio: This ratio is only slightly different from the debt-equity ratio and provides the same information. In this ratio, total assets are conveyed with respect to long-term debts. It is calculated as follows:

\(Total~assets-to-debt~ratio~=~Total~assets~/~Long-term~debts\)