There are many ratios and calculations to analyze your financial statements, but here are a few that really stand out to us.

Equity Balance

This is not a calculation or ratio, but an easy way to get a general idea of the financial position. When the Total Equity (Share Capital, Retained Earnings and Non-distributable reserves) are shown as a positive figure on the Balance Sheet. That is a good indication that the company is solvent and will not fall into financial distress easily.

Current Ratio

Current Assets vs Current Liabilities

(Shown as a ratio to 1 example 2:1)

This ratio has norms for each industry type, but a general norm is 1.5 to 3 :1. This means that should there be a crisis (like Covid) the company would atleast be able to settle it's short term debts such as creditors, credit cards and short term portion of mortgage. If the ratio is too high it could indicate a conservative investment strategy.

Acid Test

Current assets - Inventory vs Current Liabilities 

(Shown as ratio to 1 example 1:1)

The Acid test will only be applicable should their be inventory. This is calculated along with the current ratio to ensure that the short term debts could be paid even without trading. (What good would inventory be if your store is closed for a few months)

The general norm for the ratio is to be at least 1:1 or more.

Effective Tax rate (Shown as a percentage) 

Tax paid on income statement divided by Profit before tax (The Company tax rate has changed to 27%)

This might seem like something unnecessary to calculate, but this is a good indication that the financial manager/ accountant has done some sort of tax planning for the year. This is usually due to certain tax deductions that are allowable, but can't be shown on the financial statements. 

Return on Equity (ROE) (Shown as a percentage)

Profit on income statement divided by equity (Investment)

This will be a good indication of what the return on your investment is or will be. For instance: If you are thinking about buying an existing company and the ROE is lower than a risk free investment like a savings account. It would be better to put your money into a savings account or look for another investment opportunity. 

A term known to most in the field is Creative Accounting. The ratios mentioned above will only be of assistance should the financials be true and accurate. 

Here are a two of the most common creative accounting adjustments to watch out for and what you should do:

Recognizing Intangible assets to keep the company solvent. - Query the Intangible assets and the method of determining the value

Recognizing Non-distributable reserves. - Query the Non-distributable reserves and the method of determining the value. (Fair value on assets and investments)

We will discuss more ratios and things to look out for in our next post.