Financial Statements Basics: Part 3, with Jason Pereira | E085

Financial Planning For Canadian Business Owners

Today is the third part of a series that Jason is doing on understanding financial statements. Today, is about accounting ratios. Accounting ratios are used to analyze your business in several different ways. First, it’s helpful to track the performance of your business in multiple different facets, from its solvency to its profitability to its efficiency. It also is a valuable tool if you can combine comparing the help of your business with another business.

Episode Highlights:

• 1.58: Liquidity ratios measure how effectively the company can repay both short- and long-term obligations. The most important ones tend to focus on current long-term liabilities.
• 3.22: When you sell a product from inventory, you sell out a profit that is not reflected on the balance sheet.
• 4.23: The cash ratio carves all current assets except for cash and cash equivalents compared and devised by current liabilities.
• 5.45: The leverage ratios measure the amount of capital that comes in the form of debt. It’s basically how much leverage you are employing in the business relative to some other important metrics.
• 8.28: The debt service coverage ratio looks at your operating income, but it looks like your total debt service, not just the interest but also the principal payments.
• 11.45: Accounts receivable turnover measures how effective you are at collecting your receivables. The bigger the credit sales number and the smaller the average means that you have a very effective means of collecting money as fast as possible.
• 15.00: The EBT margin tells us how much our profit margins were before taxation, which is the metric for how your business will deal.
• 15.48: The net income divided by shareholder’s equity is the return on equity ratio. It is valuable because this tells you what your actual ROI is on the investment made in the business and not given.
• 17.46: The book value per share ratio takes the shareholder’s equity minus preferred equity. This may not apply to private businesses, but in public, it does.
• 19.24: The earnings per share ratio is truly a metric of how much of the business’s profitability belongs to each shareholder. You take the net earnings or net income and divide that by total shares.

3 Key Points:

1. Instead of looking at current liabilities from the lens of your current assets, the operating cash flow ratio looks at operations. It takes your operating cash flow and the cash generated from operations.
2. The interest coverage ratio measures your interest obligations on all your debt, like your operating income divided by your interest expenses. The interest coverage ratio is an important one in the short run.
3. The gross margin is your gross profit divided by your net sales. Gross profit margin is looking at the direct cost of unit sale like the cost of goods sold, cost of services rendered, whatever that related specifically to that sale.

Tweetable Quotes:

• “The current ratio looks at current assets and divides them by current liabilities. It tells you that you have enough cash and convertible assets in cash.” - Jason
• “The debt-equity ratio is taken from your total liabilities and divided by your shareholder’s equity. This is a metric of how you finance your business essentially.” - Jason
• “In many cases, businesses can rely upon lines of credit that do not require anything much more than interest payments at least every month.” - Jason

Resources Mentioned:

Facebook – Jason Pereira’s Facebook

LinkedIn – Jason Pereira’s LinkedIn

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