Current Ratio interpretation

Current Ratio interpretation
Current Ratio is a liquidity ratio that measures company's ability to pay its debt over the next 12 months or its business cycle. Current Ratio formula is:

Current ratio is a financial ratio that measures whether or not a company has enough resources to pay its debt over the next business cycle (usually 12 months) by comparing firm's current assets to its current liabilities.
Acceptable current ratio values vary from industry to industry. Generally, a current ratio of 2:1 is considered to be acceptable. The higher the current ratio is, the more capable the company is to pay its obligations. Current ratio is also affected by seasonality.
If current ratio is bellow 1 (current liabilities exceed current assets), then the company may have problems paying its bills on time. However, low values do not indicate a critical problem but should concern the management. One exception to the rule is considered fast-food industry because the inventory turns over much more rapidly than the accounts payable becoming due.
Current ratio gives an idea of company's operating efficiency. A high ratio indicates "safe" liquidity, but also it can be a signal that the company has problems getting paid on its receivable or have long inventory turnover, both symptoms that the company may not be efficiently using its current assets.

Liquidity ratios are used to determine a company's ability to meet its short-term debt obligations. Investors often take a close look at liquidity ratios when performing fundamental analysis on a firm. Since a company that is consistently having trouble meeting its short-term debt is at a higher risk of bankruptcy, liquidity ratios are a good measure of whether a company will be able to comfortably continue as a going concern.
Any type of ratio analysis should be looked at within the correct context. For instance, investors should always look at a company's ratios against those of its competitors, its sector and its industry and over a period of several years. In this issue's Fundamental Focus, we investigate liquidity ratios using time-series analysis, competitive analysis and sector and industry analysis.
As an example of how to properly examine liquidity ratios, we will use the financial statement data for J. Alexander's Corp. (JAX) found in AAII's fundamental research database, Stock Investor Pro. While you can access financial statements directly on company websites, J. Alexander's only offers two years of balance sheets at its site. For our purpose of examining trends in liquidity ratios, we need several years of financial statements in order to gather all the data. And since Stock Investor Procontains yearly balance sheet figures going back seven years, our task is made much easier if we use the data offered there rather than downloading several years of reports from another source.
You may also find financial statement data at websites such as Yahoo! Finance and SmartMoney.com. Table 1 provides all the revelvant data for calculating these ratios.
Current Ratio
The current ratio is the first of three financial ratios that we will examine. The formula for the current ratio is as follows:
Current Ratio = Current Assets ÷ Current Liabilities
As stated earlier, liquidity ratios measure a company's ability to pay off its short-term debt using assets that can be easily liquidated. In this case, the current ratio measures a company's current assets against its current liabilities. Generally, higher numbers are better, implying that the firm has a higher amount of current assets when compared to current liabilities and should easily be able to pay off its short-term debt.
As shown in Table 1, the company's 2010 current assets are $13,900,000 and its 2010 current liabilities are $13,100,000. Plugging these numbers into our formula gives us a current ratio of 1.061 (rounded to 1.1).
Table 1. Financial Statement Data for J. Alexander's Corp. (JAX)

2010
2009
2008
2007
2006
Cash & equivalents ($ thous)
$8,600
$5,600
$2,500
$11,300
$14,700
Accounts receivable ($ thous)
$2,700
$3,400
$3,900
$3,400
$2,300
Short-term investments ($ thous)
$0
$0
$0
$0
$0
Inventories ($ thous)
$1,300
$1,300
$1,400
$1,300
$1,300
Other current assets ($ thous)
$1,300
$1,500
$2,700
$2,500
$2,300
Total current assets ($ thous)
$13,900
$11,800
$10,500
$18,500
$20,600
Total current liabilities ($ thous)
$13,100
$15,200
$13,000
$14,100
$13,700

Source: AAII's Stock Investor Pro, Thomson Reuters.
Quick Ratio
The quick ratio, also known as the acid-test ratio, is a liquidity ratio that is more refined and more stringent than the current ratio. Instead of using current assets in the numerator, the quick ratio uses a figure that focuses on the most liquid assets. The main asset left out is inventory, which can be hard to liquidate at market value in a timely fashion. The quick ratio is more conservative than the current ratio and focuses on cash, short-term investments and accounts receivable. The formula is as follows:
Quick Ratio = (Cash & Equivalents + Short-Term Investments + Accounts Receivable) ÷ Current Liabilities
Once again, taking a look at the 2010 financial statements for J. Alexander's, we find that cash and equivalents are $8,600,000, accounts receivable are $2,700,000 and short-term investments are $0. Current liabilities are $13,100,000 for the year. Plugging these figures into our formula gives us a quick ratio of 0.863, rounded to 0.9, for fiscal-2010.
Cash Ratio
The cash ratio is the most conservative of the three liquidity ratios covered in this article. As the name implies, this ratio is simply the ratio of cash and equivalents compared to current liabilities. This ratio looks only at assets that can be most easily used to pay off short-term debt, and it disregards receivables and short-term investments. The argument for using the cash ratio is that receivables and short-term investments often cannot be liquidated in a timely manner. Receivables can be sold, or monetized, but the firm will not be able to get the full value of the receivables sold. Keep in mind that, due to their high liquidity, short-term Treasuries are considered cash equivalents, not short-term investments. The formula for the cash ratio is as follows:
Cash Ratio = Cash & Equivalents ÷ Current Liabilities
For fiscal-2010, the calculation for cash ratio involves using $8,600,000 for the numerator of the equation and $13,100,000 for the denominator. After plugging in the numbers, we find that the cash ratio for fiscal-2010 is 0.656, rounded to 0.7.
Interpreting the Ratios
Calculating the ratios is typically the easy part. The difficulties lie in analyzing the ratios, interpreting their meaning and making an educated investment based on the findings. As with any fundamental ratio analysis, performing a time-series analysis, a competitive analysis and industry and sector analyses are good first steps.
Table 2. Comparing Liquidity Ratios
J. Alexander's Corp. (JAX)

2010
2009
2008
2007
2006
Current ratio (X)
1.1
0.8
0.8
1.3
1.5
Quick ratio (X)
1.0
0.7
0.7
1.2
1.4
Cash ratio (X)
0.7
0.4
0.2
0.8
1.1

McCormick & Schmick's Seafood Restaurant (MSSR)

2010
2009
2008
2007
2006
Current ratio (X)
0.5
0.6
0.6
0.7
0.8
Quick ratio (X)
0.4
0.5
0.5
0.6
0.6
Cash ratio (X)
0.1
0.2
0.1
0.1
0.3

In Table 2, the liquidity ratios for 2006 through 2010 are listed for J. Alexander's and one of its main competitors, McCormick & Schmick's Seafood Restaurants (MSSR). Note that the quick ratio we calculated for J. Alexander's for 2010 is slightly different than the one shown in Table 2. Instead of short-term investments, Stock Investor Pro uses marketable securities in the numerator of the equation, causing its quick ratio calculation to be slightly higher. Either formula works as long as you remain consist in your analysis. For our analysis here, we use the figures provided by Stock Investor Pro.
As we stated, firms with higher liquidity ratios are better able to meet their short-term obligations. From Table 2, you can see that J. Alexander's has significantly higher liquidity ratios across the board compared to McCormick & Schmick's. For fiscal-2010, McCormick & Schmick's has a cash ratio of just 0.1, meaning that it only has enough cash on hand to cover 10% of its short-term obligations.
Another major observation can be made using time-series analysis. Ratios for both firms were the strongest at the end of 2006, bottomed out in late 2008, and rebounded in 2009 through the end of 2010. This can be easily explained by the recession we experienced in 2008. J. Alexander's and McCormick & Schmick's are both high-end American restaurant chains known for their steaks and seafood. The firms are classified as consumer cyclical, meaning they will follow the market cycle. As our economy fell into recession, it was natural that fewer people dined at high-end restaurants. The two firms have less cash coming in and will possibly have to borrow more in order to weather the downturn. Both of these scenarios will place an added burden on liquidity ratios. Unsurprisingly, as the economy recovered, so did the liquidity ratios.

Definition of 'Activity Ratios'

Accounting ratios that measure a firm's ability to convert different accounts within its balance sheets into cash or sales. Activity ratios are used to measure the relative efficiency of a firm based on its use of its assets, leverage or other such balance sheet items. These ratios are important in determining whether a company's management is doing a good enough job of generating revenues, cash, etc. from its resources.
Investopedia explains 'Activity Ratios'

Companies will typically try to turn their production into cash or sales as fast as possible because this will generally lead to higher revenues. Such ratios are frequently used when performing fundamental analysis on different companies. The total assets turnover ratio and inventory turnover ratio are two popular examples of activity ratios used widely across most industries.
Investopedia explains 'Inventory'

Possessing a high amount of inventory for long periods of time is not usually good for a business because of inventory storage, obsolescence and spoilage costs. However, possessing too little inventory isn't good either, because the business runs the risk of losing out on potential sales and potential market share as well.

Inventory management forecasts and strategies, such as a just-in-time inventory system, can help minimize inventory costs because goods are created or received as inventory only when needed.

Inventory turnover
The inventory turnover ratio measures the rate at which a company purchases and resells products to customers. There are two formulas for inventory turnover:

Sales OR Cost of Goods Sold
Inventory Average Inventory

The first formula is considered to be more common. The second formula accommodates the fact that sales are recorded at market value while inventory is recorded at cost, and its use of average inventory smoothes the effects of seasonal inventory changes. Because there are two formulas, it is important to be clear about which is being used when comparing inventory turnover ratios.
How it works/Example:
Let's assume Company XYZ reported the following information:

Last Year

This Year

Revenue

$1,000,000

$1,500,000

Cost of Goods Sold

$500,000

$600,000

Inventory

$95,000

$100,000
Using the first formula and the information above, we can calculate that Company XYZ's inventory turnover ratio this year was:
$1,500,000 / $100,000 = 15 times
Using the second formula, Company XYZ's inventory turnover ratio this year was:
$600,000 / ($95,000 + $100,000) / 2 = 6.15 times
This means that Company XYZ effectively replenished its inventory 15 times (or 6.15 times) during the course of the year.
Why it Matters:
In general, low inventory turnover ratios indicate a company is carrying too much inventory, which could suggest poor inventory management or low sales. Excess inventory ties up a company's cash and makes the company vulnerable to drops in market prices. Conversely, high inventory turnover ratios may indicate a company is enjoying strong sales or practicing just-in-time inventory methods. High inventory turnover also means a company is replenishing cash quickly and has a lower risk of becoming stuck with obsolete inventory. However, higher is not always better, and exceptionally high inventory turnover may indicate a company is running out of items frequently or making ineffective purchases and therefore losing sales to competitors.
It is important to understand that the timing of inventory purchases, particularly those made in preparation for special promotions or new-product introductions, can suddenly and somewhat artificially change the ratio.
Different choices in inventory accounting methods can also affect inventory turnover ratios. In periods of rising prices, companies using the last-in-first-out (LIFO) inventory method show higher costs of goods sold and lower inventories than companies using the first-in-first-out (FIFO) method. Thus, LIFO companies generally report higher inventory turnover ratios than FIFO companies, even when the companies are very similar. Additionally, companies using LIFO also tend to carry more inventory than FIFO companies; the LIFO method increases cost of goods sold, which reduces profits and in turn lowers tax liabilities.
Inventory turnover ratios vary by company as well as by industry. Low-margin industries tend to have higher inventory turnover ratios than high-margin industries because low-margin industries must offsetlower per-unit profits with higher unit-sales volume.
For all of these reasons, comparison of inventory turnover ratios is generally most meaningful among companies within the same industry, and the definition of a "high" or "low" ratio should be made within this context.

Table 3. Sector and Industry Comparison

Current Ratio (X)

2010
2009
2008
2007
2006
J. Alexander's (JAX)
1.1
0.8
0.8
1.3
1.5
Sector (services)
1.2
1.2
1.3
1.3
1.4
Industry (restaurants)
0.8
0.8
0.8
0.8
0.8

Quick Ratio (X)

2010
2009
2008
2007
2006
J. Alexander's (JAX)
1.0
0.7
0.7
1.2
1.4
Sector (services)
1.0
1.0
1.0
1.0
1.0
Industry (restaurants)
0.7
0.7
0.6
0.7
0.6

Finally, we perform an industry and sector analysis. J. Alexander's is in the services sector and the restaurants industry. Table 3 compares the current and quick ratios for J. Alexander's to its sector and industry medians. As you can see, both the company's current and quick ratios dipped significantly below the sector medians during the economic recession. Once again, this should come as no surprise. While it is to be expected that the services sector may experience slight difficulties during tough economic times, it makes sense that high-end restaurants are especially affected. The same can be said for the restaurant industry. The industry as a whole may not suffer the declines that high-end restaurants experience. Consumers may opt for fast food or low-cost diners rather than steak and seafood. Overall, J. Alexander's liquidity figures are rebounding back toward the sector medians and have always been strong compared to the industry.
Conclusion
Liquidity ratios are just a small part of fundamental analysis. Looking only at these ratios would lead you to believe that J. Alexander's is the stronger firm. Furthermore, the ratios imply that the best time to invest would have been sometime in early 2009.
However, there is often another side to the story. McCormick & Schmick's is a larger firm with more locations. Weaker liquidity ratios may be due to aggressive expansion policies. As always, it is prudent not to rely too heavily on a single set of ratios, but to research the firm as a whole.

Quick Ratio interpretation
Quick Ratio is an indicator of company's short-term liquidity. It measures the ability to use its quick assets (cash and cash equivalents, marketable securities and accounts receivable) to pay its current liabilities. Quick ratio formula is:

Quick ratio specifies whether the assets that can be quickly converted into cash are sufficient to cover current liabilities.
Ideally, quick ratio should be 1:1.
If quick ratio is higher, company may keep too much cash on hand or have a problem collecting its accounts receivable. Higher quick ratio is needed when the company has difficulty borrowing on short-term notes. A quick ratio higher than 1:1 indicates that the business can meet its current financial obligations with the available quick funds on hand.
A quick ratio lower than 1:1 may indicate that the company relies too much on inventory or other assets to pay its short-term liabilities.
Many lenders are interested in this ratio because it does not include inventory, which may or may not be easily converted into cash.

3. Explanation
Quick ratio shows the extent of cash and other current assets that are readily convertible into cash in comparison to the short term obligations of an organization. A quick ratio of 0.5 would suggest that a company is able to settle half of its current liabilities instantaneously.
Quick ratio differs from current ratio in that those current assets that are not readily convertible into cash are excluded from the calculation such as inventory and deferred tax credits since conversion of such assets into cash may take considerable time.
Quick ratio may therefore alternatively be calculated as follows:
Quick Ratio
=
Current Assets - Inventory - Advances - Prepayments

Current Liabilities
Advances to suppliers and prepayments may be excluded from the calculation as they do not result in inflow of cash resources in the future that may be used to settle liabilities.

4. Example
ABC PLC has the following assets and liabilities as at 31st December 2012:

$m
$m

Non Current Assets

Goodwill
75

Fixed Assets
75
150

Current Assets

Cash in hand
25

Cash in bank
50

Short term investments (Note 1)
75

Inventory
25

Receivable
100
275

Current Liabilities

Trade payables
100

Income tax payables
60
160

Non Current Liabilities

Bank Loan
50

Deferred tax payable
25
75
Note 1:
Short term investments include treasury bills amounting $45 million and investment in unlisted shares amounting $30 million.

Quick ratio will be calculated as follows:
Quick Ratio
=
Cash in hand + Cash at Bank + Receivables + Marketable Securities

Current Liabilities

=
25+50+45
=
0.75

160

5. Variations
In industries which typically have long receivables recovery duration such as in the construction sector, it may be appropriate to calculate the quick ratio by excluding receivables from the numerator to give a more suitable evaluation of the company's liquidity.

6. Interpretation & Analysis
Quick ratio is an indicator of solvency of an entity and must be analyzed over a period of time and also in the context of the industry the company operates in.
Generally, companies should aim to maintain a quick ratio that provides sufficient leverage against liquidity risk given the level of predictability and volatility in a specific business sector among other considerations. The more uncertain the business environment, the more likely that companies would maintain higher quick ratios. Conversely, where cash flows are stable and predictable, companies would seek to keep quick ratio at relatively lower levels. In any case, companies must achieve the right balance between liquidity risk arising from a low quick ratio and the risk of loss resulting from a high quick ratio.
A quick ratio that is greater than industry average may suggest that the company is investing too many resources in the working capital of the business which may more profitably be used elsewhere. If a company has too much spare cash, it may consider investing the surplus funds in new ventures and in case company is out of investment options it may be prudent to return the excess funds to shareholders in the form of increased dividend payments.
Acid test ratio which is lower than the industry average may suggest that the company is taking too much risk by not maintaining an appropriate buffer of liquid resources. Alternatively, a company may have a lower quick ratio due to better credit terms with suppliers than the competitors.
When analyzing the quick ratio over several periods, it is important to take into account seasonal variations in some industries which may cause the ratio to be traditionally higher or lower at certain times of the year as seasonal businesses experience irregular bursts of activities leading to varying levels current assets and liabilities over time.
- See more at: http://accounting-simplified.com/financial/ratio-analysis/quick-acid-test.html#sthash.eOi1TE9r.dpuf

Average Collection Period. This ratio measures how long a firm's average sales dollar remains in the hands of its customers. A longer collection period automatically creates a larger investment in assets.
The average collection period is calculated in two steps. The first step is calculating the average daily sales, which is done by dividing the total annual net sales by 365 days. Eastman's average daily sales is $6,849 ($2,500,000 / 365). The second step is dividing the average daily sales into accounts receivable. Eastman's average collection period is 44 days and is calculated as follows:

Accounts receivable
=
$300,000
=
44 days
Average daily sales

$6,849

If Eastman were able to collect its receivables within 30 days, the company would reduce its accounts receivable by $95,886 ($6,849 x 14 days) and thus add this amount to the company's treasury to be invested in more productive assets.
Inventory Turnover. This ratio measures the number of times a company's investment in inventory is turned over during a given year. The higher the turnover ratio, the better, since a company with a high turnover requires a smaller investment in inventory than one producing the same level of sales with a low turnover rate. Company management has to be sure, however, to keep inventory at a level that is just right in order not to miss sales.
This ratio indicates the efficiency in turning over inventory and can be compared with the experience of other companies in the same industry. It also provides some indication as to the adequacy of a company's inventory for the volume of business being handled. If a company has an inventory turnover rate that is above the industry average, it means that a better balance is being maintained between inventory and cost of goods sold. As a result, there will be less risk for the business of being caught with top-heavy inventory in the event of a decline in the price of raw materials or finished products. Here is how Eastman's ratio is calculated.

Cost of goods sold
=
$1,900,000
=
8.7 times
Inventory

$218,000

Eastman turns the average item carried in its inventory 8.7 times during the year. To be sure, not every item in the company's stock turns at the same rate. Some turn over more rapidly, while others have a slower turnover rate. Nevertheless, the overall average provides a logical starting point for positive inventory management. If Eastman were able to turn over its inventory faster, say up to 10 times a year, it would reduce its inventory from $218,000 down to $190,000 ($1,900,000 / 10) and thus add an extra $28,000 to the company's treasury.
Some companies calculate the inventory turnover by using sales instead of cost of goods sold as the numerator. This may be less appropriate because sales include a profit markup which is absent from inventory.
Fixed Assets Turnover. The fixed (or capital) assets turnover ratio measures how intensively a firm's fixed assets such as land, buildings, and equipment are used to generate sales. A low fixed assets turnover implies that a firm has too much investment in fixed assets relative to sales; it is basically a measure of productivity. The following shows how Eastman's fixed assets turnover ratio is calculated.

Sales
=
$2,500,000
=
2.1 times
Fixed assets

$1,200,000

This means that the company generates $2.10 worth of sales for dollar invested in fixed assets. If a competing firm has a $3.00 ratio, it implies that it is more productive since every dollar invested in plant assets produces an extra $0.90 in sales. If a business shows a weakness in this ratio, its plant may be operating below capacity and the manage should be looking at the possibility of selling the less productive assets.
Total Assets Turnover. This ratio takes into account both net fixed asset; and current assets. It also gives an indication of the efficiency with which assets are used; a low ratio means that excessive assets are employed to generate sales and/or that some assets (fixed or current assets) should be liquidated or reduced. Eastman's total assets turnover is as follows:

Sales
=
$2,500,000
=
1.4 times
Total assets

$1,800,000

In this case, the company produces $1.40 worth of sales for every dollar invested in total assets. If Eastman is able to reduce its investment in accounts receivable and inventory and/or sell a division or fixed assets which are a burden on the company's operating performance, it would increase the total assets turnover ratio and thus would be more productive.

Average Collection Period interpretation
Average Collection Period represents the average number of days it takes the company to convert receivables into cash. Average Collection Period formula is:

Average collection period measures the average number of days that accounts receivable are outstanding. This activity ratio should be the same or lower than the company's credit terms.
As a rule, outstanding receivables should not exceed credit terms by more than 10-15 days.
If you allow various types of credit transactions, then the average collection period MUST be also calculated separately for each category.
This ratio takes in consideration ONLY the credit sales. If the cash sales are included, the ratio will be affected and may lose its significance. It is best to use average accounts receivable to avoid seasonality effects. If the company uses discounts, those discounts must be taken into consideration when calculate net accounts receivable.
Average Collection Period is figured as days. A popular variant of this ratio is to convert it intoreceivables turnover ratio in terms of "turnover times".
Related resources

Inventory turnover
Inventory Turnover Ratio measures company's efficiency in turning its inventory into sales. Its purpose is to measure the liquidity of the inventory.
Inventory Turnover Ratio is figured as "turnover times". Average inventory should be used for inventory level to minimize the effect of seasonality.
This ratio should be compared against industry averages.
A low inventory turnover ratio is a signal of inefficiency, since inventory usually has a rate of return of zero. It also implies either poor sales or excess inventory. A low turnover rate can indicate poor liquidity, possible overstocking, and obsolescence, but it may also reflect a planned inventory buildup in the case of material shortages or in anticipation of rapidly rising prices.
A high inventory turnover ratio implies either strong sales or ineffective buying (the company buys too often in small quantities, therefore the buying price is higher).A high inventory turnover ratio can indicate better liquidity, but it can also indicate a shortage or inadequate inventory levels, which may lead to a loss in business.
High inventory levels are usual unhealthy because they represent an investment with a rate of return of zero. It also opens the company up to trouble if the prices begin to fall.
A good rule of thumb is that if inventory turnover ratio multiply by gross profit margin (in percentage) is 100 percent or higher, then the average inventory is not too high.

Definition of 'Fixed-Asset Turnover Ratio'

A financial ratio of net sales to fixed assets. The fixed-asset turnover ratio measures a company's ability to generate net sales from fixed-asset investments - specifically property, plant and equipment (PP&E) - net of depreciation. A higher fixed-asset turnover ratio shows that the company has been more effective in using the investment in fixed assets to generate revenues.
The fixed asset turnover ratio measures the company's effectiveness in generating sales from its investments in plant, property, and equipment. It is especially important for a manufacturing firm that uses a lot of plant and equipment in its operations to calculate this ratio.
Here is how the fixed asset turnover ratio is calculated:
Net Sales/Net Plant and Equipment (Net Fixed Assets) = X Times
The denominator in the equation should be net of accumulated depreciation.
Interpretation: If the fixed asset turnover ratio is low as compared to the industry or past years of data for the firm, it means that sales are low or the investment in plant and equipment is too high. This may not be a serious problem if the company has just made an investment in fixed asset to modernize, for example.
If the fixed asset turnover ratio is too high, then the business firm is likely operating over capacity and needs to either increase its asset base (plant, property, equipment) to support its sales or reduce its capacity.

Total asset turnover
The total asset turnover ratio measures the ability of a company to use its assets to efficiently generate sales. This ratio considers all assets, current and fixed. Those assets include fixed assets, like plant and equipment, as well as inventory, accounts receivable, as well as any other current assets.
The calculation for the total asset turnover ratio is:
Net Sales/Total Assets = # Times
Interpretation: The lower the total asset turnover ratio (the lower the # Times), as compared to historical data for the firm and industry data, the more sluggish the firm's sales. This may indicate a problem with one or more of the asset categories composing total assets - inventory, receivables, or fixed assets. The small business owner should analyze the various asset classes to determine in which current or fixed asset the problem lies. The problem could be in more than one area of current or fixed assets.
Since current assets also include the liquidity ratios, such as the current and quick ratios, a problem with the total asset turnover ratio could also be traced back to these ratios.
Many business problems can be traced back to inventory but certainly not all. The firm could be holding obsolete inventory and not selling inventory fast enough. With regard to accounts receivable, the firm's collection period could be too long and credit accounts may be on the books too long. Fixed assets, such as plant and equipment, could be sitting idle instead of being used to their full capacity. All of these issues could lower the total asset turnover ratio.
What if the total asset turnover is excellent as compared to historical data for the firm and to industry data? That means your firm is utilizing all its assets - its asset base - efficiently to generate sales and that is a very good thing

If a company can generate more sales with fewer assets it has a higher turnover ratio which tells it is a good company because it is using its assets efficiently. A lower turnover ratio tells that the company is not using its assets optimally. Total asset turnover ratio is a key driver of return on equity as discussed in the DuPont analysis.
Example
As at 1 January 2011 Gamma had total assets of $100, total fixed assets of $60 and net working capital of $20. During FY 2011 it generated sales of $200 with COGS of $160 and its total assets as at 30 December 2011 were $120. During the year it charged depreciation of $10 and there were no fixed asset additions during the year. Current assets and current liabilities were $50 and $30 as at the year end. Calculate total asset turnover, fixed asset turnover and working capital turnover ratios.
Solution
Average total assets = (100+120)/2 = $110, sales are $200 so total asset turnover is $200/$110 = 1.82. If the industry average total asset turnover ratio is 1.2 we can conclude that the company has used its asset more effectively in generating revenue.
Opening fixed assets were $60, closing fixed assets are $60-$10=$50. Average fixed assets are hence ($60+$50)/2=$55. This gives us fixed asset turnover of $200/$55 = 3.63
Opening working capital is $20, closing working capital is $20 ($50-$30); this gives us average working capital of $20 and resulting working capital turnover ratio of $200/$20=10.
Asset turnover ratio should be looked at together with the company's financing mix and its profit margin for a better analysis as discussed in DuPont analysis.

Definition of 'Leverage Ratio'

1. Any ratio used to calculate the financial leverage of a company to get an idea of the company's methods of financing or to measure its ability to meet financial obligations. There are several different ratios, but the main factors looked at include debt, equity, assets and interest expenses.

Definition
The debt-to-equity ratio (debt/equity ratio, D/E) is a financial ratio indicating the relative proportion of entity's equity and debt used to finance an entity's assets. This ratio is also known as financial leverage.
Debt-to-equity ratio is the key financial ratio and is used as a standard for judging a company's financial standing. It is also a measure of a company's ability to repay its obligations. When examining the health of a company, it is critical to pay attention to the debt/equity ratio. If the ratio is increasing, the company is being financed by creditors rather than from its own financial sources which may be a dangerous trend. Lenders and investors usually prefer low debt-to-equity ratios because their interests are better protected in the event of a business decline. Thus, companies with high debt-to-equity ratios may not be able to attract additional lending capital.
Calculation (formula)
A debt-to-equity ratio is calculated by taking the total liabilities and dividing it by the shareholders' equity:
Debt-to-equity ratio = Liabilities / Equity
Both variables are shown on the balance sheet (statement of financial position).
Norms and Limits
Optimal debt-to-equity ratio is considered to be about 1, i.e. liabilities = equity, but the ratio is very industry specific because it depends on the proportion of current and non-current assets. The more non-current the assets (as in the capital-intensive industries), the more equity is required to finance these long term investments.
For most companies the maximum acceptable debt-to-equity ratio is 1.5-2 and less. For large public companies the debt-to-equity ratio may be much more than 2, but for most small and medium companies it is not acceptable. US companies show the average debt-to-equity ratio at about 1.5 (it's typical for other countries too).
In general, a high debt-to-equity ratio indicates that a company may not be able to generate enough cash to satisfy its debt obligations. However, a low debt-to-equity ratio may also indicate that a company is not taking advantage of the increased profits that financial leverage may bring.

Definition
Debt ratio is a ratio that indicates the proportion of a company's debt to its total assets. It shows how much the company relies on debt to finance assets. The debt ratio gives users a quick measure of the amount of debt that the company has on its balance sheets compared to its assets. The higher the ratio, the greater the risk associated with the firm's operation. A low debt ratio indicates conservative financing with an opportunity to borrow in the future at no significant risk.
Debt ratio is similar to debt-to-equity ratio which shows the same proportion but in different way.
Calculation (formula)
The debt ratio is calculated by dividing total liabilities (i.e. long-term and short-term liabilities) by total assets:
Debt ratio = Liabilities / Assets
Both variables are shown on the balance sheet (statement of financial position).
Norms and Limits
The optimal debt ratio is determined by the same proportion of liabilities and equity as a debt-to-equity ratio. If the ratio is less than 0.5, most of the company's assets are financed through equity. If the ratio is greater than 0.5, most of the company's assets are financed through debt.
Maximum normal value is 0.6-0.7. But it is necessary to take into account industry specific, explained in the article about debt-to-equity ratio.

Gross profit margin ratio
The gross profit margin ratio expresses the gross profit as a proportion of sales.
Note: gross profit is used to calculate the gross profit margin ratio
The gross profit margin ratio is used as one indicator of a business's financial health. It shows how efficiently a business is using its materials and labour in the production process and gives an indication of the pricing, cost structure, and production efficiency of your business. The higher the gross profit margin ratio the better.
Gross profit margin ratio = gross profit ÷ income
The gross profit margin is simply the gross profit margin ratio expressed as a percentage:
Gross profit margin (%) = (gross profit ÷ income) x 100
Larger gross profit margins are better for businesses
The higher the percentage, the more the business retains of each dollar of sales, which means more money is left over for other operating expenses andnet profit.
A low gross profit margin ratio means that the business generates a low level of revenue to pay for operating expenses and net profit. It indicates that either the business is unable to control production and inventory costs or that prices are set too low.
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Net profit margin ratio
The net profit margin ratio is the net profit as a proportion of sales.
The net profit margin ratio shows the proportion of every dollar of sales that is left after all expenses have been paid, and remains as net profit.
Net profit is used to pay for interest, tax and distribution to the owners. The higher the net profit margin ratio the better.
Net profit margin ratio = net profit ÷ income
The net profit margin is simply the net profit margin ratio expressed as a percentage:
Net profit margin (%) = (net profit ÷ income) x 100
A high net profit margin ratio demonstrates how effective your business is at converting sales into profit. It may mean that you are capitalising on some competitive advantage that can provide your business with extra capacity and flexibility during the hard times.
A low net profit margin ratio may mean that you are not generating enough sales, the gross profit margin is too low, or that you are not keeping your operating expenses under control to leave an acceptable profit.
A decrease in the net profit margin ratio over time may indicate cost blowouts that require efficiency improvements. A business with a low ratio might need to take on debt to pay its expenses.

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Net profit margin ratio
The net profit margin ratio is the net profit as a proportion of sales.
The net profit margin ratio shows the proportion of every dollar of sales that is left after all expenses have been paid, and remains as net profit.
Net profit is used to pay for interest, tax and distribution to the owners. The higher the net profit margin ratio the better.
Net profit margin ratio = net profit ÷ income
The net profit margin is simply the net profit margin ratio expressed as a percentage:
Net profit margin (%) = (net profit ÷ income) x 100
A high net profit margin ratio demonstrates how effective your business is at converting sales into profit. It may mean that you are capitalising on some competitive advantage that can provide your business with extra capacity and flexibility during the hard times.
A low net profit margin ratio may mean that you are not generating enough sales, the gross profit margin is too low, or that you are not keeping your operating expenses under control to leave an acceptable profit.
A decrease in the net profit margin ratio over time may indicate cost blowouts that require efficiency improvements. A business with a low ratio might need to take on debt to pay its expenses.

It is a measurement of what proportion of a company's revenue is left over, before taxes and other indirect costs (such as rent, bonus, interest, etc.), after paying for variable costs of production as wages, raw materials, etc. A good operating margin is needed for a company to be able to pay for its fixed costs, such as interest on debt. A higher operating margin means that the company has less financial risk.
Operating margin can be considered total revenue from product sales less all costs before adjustment for taxes, dividends to shareholders, and interest on debt.
Operating margin is a measure of profitability. It indicates how much of each dollar of revenues is left over after both costs of goods sold and operating expenses are considered.
The formula is for calculating operating margin is:
Operating Margin = Operating Earnings / Revenue
How it works/Example:
It is important to understand what expenses are included and excluded when calculating operating margin. The calculation starts with operating earnings, which is equal to revenue minus cost of goods sold, labor and other day-to-day expenses incurred in the normal course of business. It typically excludes interest expense, nonrecurring items (such as accounting adjustments, legal judgments or one-time transactions) and other income statement items not directly related to a company's core business operations.
To see how operating margin works, consider Company XYZ's income statement:

Using this information and the formula above, we can calculate that Company XYZ's operating margin is:
Operating Margin = $150,000 / $1,000,000 = 0.15 or 15%
This means that for every $1 in sales, Company XYZ makes $0.15 in operating earnings.
Why it Matters:
Operating margins are important because they measure efficiency. The higher the operating margin, the more profitable a company's core business is.
Several things can affect operating margin (such as pricing strategy, prices for raw materials or labor costs), but because these items directly relate to the day-to-day decisions managers make, operating margin is also a measure of managerial flexibility and competency, particularly during rough economic times.
It is also important to note that some industries have higher labor or materials costs than others. This is why comparing operating margins is generally most meaningful among companies within the same industry, and the definition of a "high" or "low" ratio should be made within this contex

Current Ratio interpretation

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