Balance Sheet Ratios
Balance sheet ratios are financial metrics that determine relationships between different aspects of a company’s financial position i.e. liquidity vs. solvency. They include only balance sheet items i.e. components of assets, liabilities and shareholders equity in their calculation.
Balance sheet is the financial statement that provides a picture of a company’s financial position by listing a company’s assets, liabilities and shareholders equity. Income statement and cash flows statement provides information about profitability and cash flows.
A financial ratio determines relationship between two components. These may include:
- Two balance sheet components, i.e. assets, liabilities and shareholders’ equity
- Two income statement components, i.e. sales, gross profit, net income, etc.
- A balance sheet component and an income statement component
- An income statement component and a cash flows statement component
- A balance sheet component and a cash flows statement component
A balance sheet ratio belongs to the first category, i.e. it includes either two classes of assets, assets and liabilities, assets and shareholders equity, liabilities and shareholders equity.
Identify which of the following are balance sheet ratios:
- Debt ratio
- Debt to equity ratio
- Return on shareholders equity
- Current ratio
- Quick ratio
- Cash flows per share
- Equity multiplier
Debt ratio is a balance sheet ratio. It is calculated by dividing total liabilities by total assets, both of which are balance sheet components.
Debt to equity ratio is a balance sheet ratio because it is calculated by dividing total liabilities by total shareholders equity, both of which are balance sheet items.
Return on shareholders equity is calculated by dividing net income by total shareholders equity, one of which is income statement element. Hence, the ratio is not a balance sheet ratio.
Current ratio = current assets/current liabilities, both of which are balance sheet items and hence it is a balance sheet ratio.
Quick ratio is also a balance sheet ratio because the numerator (current assets – inventories) and the denominator (current liabilities) are both balance sheet items.
Cash flows per share (CFS) is not a balance sheet ratio because the denominator is a cash flows statement component.
Equity multiplier total assets in numerator and total shareholders equity in denominator and hence the ratio is a balance sheet ratio.
The majority of the ratios identified as balance sheet ratios are either liquidity ratios (current ratio and quick ratio) or solvency ratios (debt ratio, debt to equity ratio, equity multiplier).