Key Financial Ratios
Sureties, banks and other creditors measure your business's financial
strength by reviewing financial trends and numerical relationships using the
information presented on your financial statements. To do this, they
typically calculate a variety of financial ratios. Comparing ratios from
current periods to ratios from prior periods and to industry standards
provides insight into your company's financial health and the potential risk
of extending or guaranteeing credit.
Reviewing your firm's financial ratios with us on a regular basis can help
you better manage your company's finances. Some of the ratios that can be
important include:
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Profitability ratios, such as gross profit margin, return on assets and return on equity. These ratios show how effectively your company is using its resources and curtailing costs to produce profits.
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Liquidity ratios, such as the current ratio. Liquidity ratios measure your firm’s ability to pay off short-term obligations as they become due.
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Underbilling ratios, such as the underbillings to equity ratio. This ratio measures the percentage of your company’s net worth represented by work performed but not yet billed. A ratio greater than 20 percent is considered unusual and would be a cause for concern. The underbillings to working capital ratio reveals the percentage of your working capital that is composed of underbillings.
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Backlog ratios indicate how long it will take to complete work under contract (number of months in backlog) and the remaining gross profit not yet earned on contracts that haven’t been completed (backlog gross profit).
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Asset utilization ratios measure the efficiency of your company’s use of its assets. For example, your fixed asset ratio will show to what extent fixed assets make up your company’s equity. If the percentage seems too high, creditors and sureties may regard your company’s investment in fixed assets as excessive.
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Debt utilization ratios allow you to measure your company’s liabilities in relation to its asset base and earnings ability. For example, if your company has a high debt-to-equity ratio, it means that your company is financing its assets using a large amount of borrowed funds.
Financial Ratios
| The Ratio | How It’s Calculated | What It Means |
| Current Ratio | Current Assets ÷ Current Liabilities | Will current assets be enough to meet current liabilities? |
| Return on Equity | Net Earnings (before income taxes) ÷ Total Net Worth | Are your assets effectively generating profits? |
| Equity to Overhead | Total Net Worth ÷ General & Administrative Expenses | Are your overhead expenses appropriate for the size of your company? |
| Gross Profit Margin | (Net Sales – Cost of Goods Sold) ÷ Sales | What’s the difference between revenues and cost of sales? Is it enough to meet selling and administrative expenses? |
| Debt-to-Equity | Total Liabilities ÷ Stockholders’ Equity (or Net Worth) | How heavily is your company leveraged? |
| Fixed Asset Ratio | Net Fixed Assets ÷ Total Net Worth | Does your business have enough liquid funds for current operations? |
| Return on Assets | Net Earnings (before income taxes) ÷ Average Total Assets | Are your assets being used effectively to generate profits? |
| Backlog to Working Capital | Average Backlog in Dollars ÷ (Current Assets – Current Liabilities) | How much accumulated committed work do you have in relation to working capital? |
Talk to Us
Financial ratios can give you a snapshot of your company's fiscal health.
They can also help you identify potential problems that may require you to
take corrective measures. Please
contact us for assistance
in analyzing your company’s financial statements and tracking key ratios.
This is one of the key services we provide as part of our
Contractor Toolbox and our
A/E Toolbox.
Work-In-Process is provided by
Somerset for our clients and other interested persons upon request.
Since technical information is presented in generalized fashion, no
final conclusion on these topics should be made without further review.
For additional information on the issues discussed,
please contact
Ken
Hedlund,
Jay Feller,
Steve George,
Chris
Mayfield or
Rebecca Ogle
of our
Construction & A/E Team.
This document is not intended or written to be used, and cannot be used,
for the purpose of avoiding tax penalties that may be imposed on the
taxpayer.
Somerset CPAs,
P.C.
3925 River Crossing Parkway, Third Floor
Indianapolis, Indiana 46240
317.472.2200 • 800.469.7206 • FAX 317.208.1200
www.IndianaConstructionCPAs.com
