We’ve listed a few of the quick financial measures you can run on your customers (or suppliers) to check their business health. We’re sure you’d agree that in ths current economic climate any insight into the long term viability of your customers and suppliers is fairly useful.
If the company you are looking at is listed on the stock exchange you should be able to access these measures through a number of financial websites online without needing to employ any maths, (our favourite is www.advfn.co.uk) but don’t worry if the company isn’t listed as you can work these measures out with just the company’s annual reports logged at Companies House (for those based in the UK) and a calculator.
Current Ratio
Current Assets (CA) Divided by Current Liabilities (CL)
Current assets divided by current liabilities i.e. the ability (in theory) of a company to meet its short term debt on demand, for instance, if it went into receivership.
Strictly speaking this ratio should be greater or equal to 1, although in practice a much lower value is widely accepted (one of the effects of Just-In-Time).
Quick Ratio (acid test)
Current Assets (CA) – Stocks Divided by Current Liabilities
Current assets less stocks divided by current liabilities.
The rationale here is that stocks cannot be quickly converted into cash in order to meet short term debt on demand, and hence they are deducted from current assets.
In theory, a company’s quick ratio should be greater or equal to 1, or it is insolvent. However, a much lower figure is generally accepted today, provided that the company is considered to be financially stable.
Return on Capital Employed (ROCE) %
Net Profit before taxation x 100
Fixed Assets (FA) + Current Assets (CA) – Current Liabilities
Net profit (profit before taxation) as a percentage of the capital tied up in the business i.e. the company’s profitability.
The higher the ration the more profitable the company. Relate this to net margin and capital turnover.
The percentage return must be compared with alternative investment opportunities, such as returns offered on bank accounts.
If investment in the bank can yield a guaranteed 7 per cent plus (depending on interest rates at the time), a company should show a return of around 20 per cent in order to justify using those funds at a higher level of risk.
Debtor Period (days)
365 X Debtors Divided by Turnover
The average number of days credit given to customers i.e. how long it takes the company to get its money in.
