Accountants use many formulas in calculating the value of balance sheets. The formulas test the financial strength, efficiency and liquidity of a company. The balance sheet tells us what assets a business owns, liabilities it owes and its net worth on a certain date. While this information is useful to set goals for the company, do not use it as the only basis for company decision making. Some formulas use numbers from the Income Statement in combination with the balance sheets in calculating value.
Find a company's working Capital by subtracting the current liabilities from the current assets. This tells us how much of the company's current debt is exceeded by liquid assets.
Calculate the working capital for each dollar of sales by dividing working capital by total sales. This tells the investor how long it takes the company to make sales revenue from working capital. Of course, it is better for a company to do this as fast as possible.
Compare current ratios to the ratios from previous accounting periods to get an idea of how the company is improving efficiency, or not, over time. You may also need to compare these ratios to industry standards for the particular business.
Divide a company's net credit sales by the average net receivables to help determine a company's efficiency. This tells you how quickly customers are paying their bills, which will help you understand if the company is making good credit decisions when offering accounts.
Determine inventory turnover by dividing costs of goods sold by the average Inventory for the accounting period. You can also divide the cost of goods sold by average inventory. A low inventory turnover, when used in comparison with industry average, would imply that sales are poor for the company or the inventory is too high. When the ratio is high, compared to industry standard, the company has either excellent sales, or the buyer is doing a poor job.
Calculate the acid test ratio. Doing so will tell you to what extent a company could pay its current debts without future sales to do so. This formula uses cash and any assets that can be converted quickly into cash such as accounts receivable and marketable securities. Add cash, accounts receivable and any quick assets. Divide this by the current liabilities.
Find the debt to equity for the company by dividing total debts by total net worth or equity. This shows how much the owners have invested in the company compared with how much creditors have invested.
Use a variety of formulas and ratios from a combination of financial reports for an accurate picture of business value.
When deciding to buy or sell a business do not base decisions solely on balance sheet formulas.
- When deciding to buy or sell a business do not base decisions solely on balance sheet formulas.
- Use a variety of formulas and ratios from a combination of financial reports for an accurate picture of business value.