ave you ever wondered what a banker looks at when reviewing financial statements? If you have applied for a loan before, you’ve probably been asked to provide a copy of your financials. A banker will review these documents and compute a variety of ratios to determine the financial health of a company. Various internal (managers) and external (bankers, bonding companies) users utilize financial statements to make informed decisions about a company’s future and to understand how a company has performed. Financial ratios can be broken down into four main categories—profitability, liquidity, leverage, and efficiency.

• Gross Profit Margin Ratio: (revenue – cost of goods sold)/revenue. This ratio provides the gross profit in each sales dollar, indicating a company’s profitability on contracts. The percentage will vary depending on the type of work it performs (remodeling, specialty work, or new construction).
• Operating Profit Margin Ratio: operating profit/revenue. This ratio indicates a return on sales and how efficient it is at generating profits from sales.
• Net Profit Margin: net income/revenue. Net profit margin measures how much each dollar in revenue collected by a company translates to profit.

• Working Capital: current assets – current liabilities. This measures a company’s liquidity. If current liabilities exceed current assets, then a company may not be able to pay back its creditors.
• Current Ratio: current assets/current liabilities. This measures the ability to pay short-term (within one year) debt and payables. A ratio of less than 1.00 could indicate potential financial instability; however, a ratio of more than 3.00 could reflect inefficient use of working capital.
• Quick Ratio: (current assets – inventory)/current liabilities. The quick ratio is slightly more conservative than the current ratio, as it does not include inventory and sometimes prepaid expenses are excluded. This measures the ability to pay short-term debt and payables using a company’s most liquid assets. If your quick ratio is less than 1.00, this is an indicator a company is unable to quickly convert assets to cash in order to cover current liabilities.

• Debt-To-Equity Ratio: total liabilities/total equity. A high debt-to-equity ratio can be associated with high risk and reflects the way a company is leveraging its assets by financing. It also determines the company’s ability to meet all financial obligations over an extended period of time.
• Return on Equity Ratio: income before taxes/total equity. Indicates the profit generated by the net assets employed. This ratio reflects the stockholders’ return on investment and is stated as a percentage. A high ratio may reflect an undercapitalized situation or a very profitable company.

• Receivables Turnover Ratio: net credit sales/average accounts receivable. Measures the efficiency with which a company collects on its receivables. This can also determine how many times the receivables are converted to cash in a period.
• Fixed Asset Turnover Ratio: revenue/net fixed assets. A higher ratio may interpret greater efficiency in managing fixed assets; however, it is best practice to review what these ratios are year over year.
• Asset Turnover Ratio: revenue/(beginning assets + ending assets). A high asset turnover ratio indicates a company is generating more revenue per dollar of assets.

I have only touched on a few financial ratios; however, reviewing these can assist in determining how well a company is performing.

You have one chance per year to use financial statements to tell a story—make sure the numbers portray the narrative you want others to read.