Captial Ratios: Safety Margins (1 of 6)
March 11, 2010, 5:00 am
Copyright © 2010 Integrated Profitability TM
Equity-Capital ratios that focus on a company’s safety margin are the main point of the Small Business Finance & Profitability Equity-Capital series:
● How large is your financial cushion?
● Are you well-capitalized?
Here are two major “safety margins” that are widely used:
Debt / Shareholder Equity
Purpose: to assess how leveraged your company is and, more specifically since debt is paid off first, how much cash is available to cover financial challenges (in the worst case, this ratio indicates how much value would be left for shareholders/owners if the company had to be liquidated)
2. Working Capital Ratio (Current Ratio)
Current Assets / Current Liabilities
Purpose: to know how well your current assets (e.g., cash) cover your current liabilities (e.g., short-term accounts payable)
CPAclass.com is a helpful website with a good list of main financial ratios.
These two ratios are useful in assessing the financial health of a company, particularly the ability to pay bills and debt. However, they are calculated from items on the Balance Sheet, not from the dynamism of the Income Statement which is where many, if not most, financial difficulties come from for small businesses.
To reiterate the benefits and uses of equity-capital:
● Funding for the business: more money can be poured into improving the company
● Weathering rough patches: money can be used to plug gaps in net-profit
● Rewarding investors: dollars can be returned to your investors
Subsequent installments of this article delve more deeply into ways to identify and quantify those rough spots—and gauge how adequate your equity-capital is to survive them. Something along the lines of whether or not you have enough tarmac to fill in the pot-holes your business might be hitting.
The next article is scheduled for April 29, 2010: during the week devoted to “Risk.”
Bill
William A. Stong
Email: william.a.stong@gmail.com
SBF&P # 57
Telephone: 925-202-6244
Copyright © 2010 Integrated Profitability TM
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