- Tests of a Company's Financial Strength and Liquidity:
Working Capital: Current Assets - Current Liabilities
Working capital per share = working capital / total shares outstanding
If you could buy a stock at working capital per share, you would be getting all of the company's fixed assets (real estate, computers, long term investments, etc.) plus its earnings / profit each year from now until eternity for free! The company will probably never trade that low; but you should always keep this in mind when analyzing a business. Sometimes, especially during serious economic downturns, you will find companies selling close to working capital.
Working Capital per Dollar of Sales: Working Capital ÷ Total Sales
Manufacturers of heavy machinery require the most working capital and range from 20-25%.
Current Ratio: Current Assets ÷ Current Liabilities
The current ratio should be at least 1.5 but probably not over 3 or 4.
Too low current ratio means the company may have difficulty to pay off its current debts. Too high current ratio means the management isn’t utilizing the money efficiently.
Quick / Acid Test / Current Ratio: Current Assets minus inventory (called "Quick Assets) ÷ Current Liabilities
Inventory is what causes the biggest difference between the current and quick ratio. The quick ratio was designed to measure the immediate resources of a company against its current liabilities.
Debt to Equity Ratio: Total Liabilities ÷ Shareholders' Equity
Generally, any company that has a debt to equity ratio of over 40% to 50% should be looked at more carefully to make sure there are no liquidity problems.
- Tests of a Company's Efficiency:
Receivable Turnover: Net Credit Sales ÷ Average Net Receivables for the Period
Average Age of Receivables: Numbers of days in period ÷ Receivable Turnover
Inventory Turnover: Cost of Goods Sold ÷ Average Inventory for the Period
Number of Days for Inventory to Turn: Number of days in Period ÷ Inventory Turnover
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