A company's financial situation gets captured in its balance sheet, depicting its cash position, assets, and debt obligations. However, deeper insights can be gleaned from calculating a few vital ratios present in the balance sheet.
The current ratio, for instance, indicates if a company possesses enough short-term assets to cover its short-term bills. It is calculated by dividing current assets by current liabilities, with a result of 1.2 or higher typically deemed as satisfactory, given the industry context.
Another useful measure is the quick ratio, a conservative index that excludes inventories from the calculation. It gives a truer picture of the company's ability to meet short-term financial obligations using liquid assets.
The comparison of current assets to current liabilities renders the working capital. This metric can be positive or negative, depending on the industry context. While certain industries prefer positive working capital, others like consumer businesses favor a negative working capital, considered an efficient resource use.
Lastly, the debt-to-equity ratio is a critical ratio derived from a balance sheet. It conveys the extent of dependency a business has on debt, representing balance between what is owed and what is owned.
Understanding these four key financial ratios: current ratio, quick ratio, working capital, and debt-to-equity ratio, and their industry-specific benchmarks, can offer profound insights into a company's financial health. Try applying these calculations on various companies' balance sheets to interpret and compare their financial standings.