Despite similar sales and net profit ratios, Company B will struggle to survive.
In four of the five ratios, total assets play a part, and a higher score is better. For most remodeling companies, total assets consist of cash and accounts receivable plus vehicles, office equipment, computers, and the like. These four ratios attempt to measure the ability to translate these assets into sales.
The fifth ratio measures company ownership by comparing total debt to total equity. Lower is better, but I’ve flipped it on its head so that a higher score is better and it’s consistent with the other elements in the model.
Sales ÷ Total Assets measures the ability of company assets to generate sales. A high score indicates successful sales techniques, positive client satisfaction, effective marketing programs, and products and services appropriate to the market served.
Net Profit ÷ Total Assets measures the company’s bottom line relative to its assets. A high score reflects good company overhead control.
Working Capital ÷ Total Assets, where working capital is defined as the difference between current assets and current liabilities. A higher score means more liquidity, which provides greater flexibility.
Retained Earnings ÷ Total Assets measures what portion of total assets are kept in the company. A higher percentage is better.
Equity ÷ Debt indicates who truly owns your company; you (equity is greater than debt) or others (debt is greater than equity).
As you can see in the example below, a higher total score is better. Company B’s strong performance in Sales and Net Profit is, however, dragged down by too much debt, negative working capital and retained earnings, poor cash flow, and no savings. This is a difficult position to overcome, but it’s not impossible. Knowing what the problems are is the first step to recovery.
—Judith Miller is a Seattle–based business consultant and trainer. remodelservices.com