Fleet Management News & Business Info | Commercial Carrier Journal
Issue link: http://read.dmtmag.com/i/493405
74 COMMERCIAL CARRIER JOURNAL | APRIL 2015 By now, you have developed a solid basic understanding of financial statements. Now it's time to learn what sophisticated readers do with these numbers. Bankers, accountants, credit analysts, financial officers and potential buyers pull certain numbers out of the financial reports and perform mathematical calculations, called financial ratios, to measure your company's health. Your own personal health, as mea- sured by your annual physical exam, is a good model for how this works. After your lab work comes back, your doctor examines your blood test results and discusses them with you. He might say your cholesterol count is 185, which by itself means nothing to you, and you have no idea how the lab arrived at that figure. If the doctor says that you gener- ally are healthy as long as the number stays below 200, you relax. But if he says that over the last four years it's climbed steadily from 140, then you need to explore ways of reducing the number. Financial ratios and analyses are no different. You don't have to be an expert at the computation, but you should know what the ratios say about your company's financial health. Also, lenders almost always have loan covenants that dictate the minimum ratios the company must achieve. Financial ratios help you compare current results with your company's trends over time and with the current results of others. By examining the same ratio over time, you can determine whether the company is getting stronger or weaker in the area the ratio measures. Similarly, you can compare your profit margin to that of another company or to industry averages. Using ratios this way helps analysts make sense of pure dollar amounts, which can be confus- ing when comparing companies hav- ing different revenues or assets. Owners or managers who don't have financial backgrounds might not real- ize that they already use ratios in their companies. If you've ever signed for a business loan, you likely agreed to keep the financial condition of your company within certain bounds. These affirmative covenants appear in the loan agreement as minimum financial ratios. Is your company in compliance? You won't know unless someone in your company regularly computes the ratios. There are dozens of financial ratios, but they com- monly fall into major groupings. Liquidity ratios measure the compa- ny's working capital and how it is man- aged. It takes money to make money. Has the company invested enough to keep operating? How financially liquid or flexible is the company? Working capital is that part of the company's current assets needed to keep its doors open: cash in the bank, plus receivables and other current assets, minus amounts borrowed from creditors for short-term needs. These may include lines of credit; payables due suppliers, drivers and employees; and for taxes. Although employees expect to be paid as often as weekly and vendors at least monthly, your customers might take 45 to 60 or more days to pay. That's why you need more current assets than current liabilities. In other words, you need working capital. Suppose your current assets total $1 million and your current liabilities total $750,000. That leaves net work- ing capital of $250,000. Without work- ing capital, you will spend so much time making ends meet and answering calls from creditors that sales, opera- tions and profits will suffer. Current ratios are current assets divided by current liabilities. In our example, $1 million divided by $750,000 produces a current ratio of 1.33 to 1. The minimum healthy The following is an excerpt from How to Use Financial Statements, a manual produced by Commercial Carrier University. CCU is an educational program produced by Commercial Carrier Journal that includes business management manuals, seminars aimed at improving management skills and a website. For more informa- tion, visit www.commercialcarrieruniversity.com. UNDERSTANDING FINANCIAL RATIOS