How to Extract Insightful Financial Ratios from QuickBooks

May 17, 2013 by Ed Becker

Hidden among the mountains of data you have accumulated in QuickBooks lies several eye-opening financial ratios. These ratios are essential in corporate finance, but are also extremely effective at analyzing the financial strength of small businesses.

The Current Ratio

Current Ratio = Current Assets / Current Liabilities

Does your business have the ability to pay its debts in the next 12 months? The sole purpose of the current ratio is to answer this important liquidity question.

You can easily calculate the current ratio by running a “Balance Sheet Detail” report in QuickBooks Pro. Locate your total current assets and divide by your total current liabilities. Hopefully, your current ratio is 1.0 or higher, which means your business can comfortably pay all short-term obligations. A current ratio below 1.0 means your short-term debt exceeds the value of your current assets, leaving you vulnerable to insolvency.

The Quick Ratio

Quick Ratio = [Current Assets – (Inventory + AR)] / Current Liabilities

The quick ratio, also known as the “Acid Test” ratio, provides a deeper liquidity analysis than the current ratio. In the real world, most businesses would not be able to instantly convert inventory and accounts receivable into cash. The quick ratio excludes these two current assets to gauge the ability to pay all current liabilities as if payment was required immediately. It will also show you how dependent your liquidity is on inventory, which is especially helpful for retail stores.

Use the same “Balance Sheet Detail” report to locate your current assets, but this time, subtract inventory and accounts receivable from total current assets. Next, divide the amount by total current liabilities. Just like the current ratio, a result of 1.0 or higher shows financial strength.

Return on Assets (ROA)

Return on Assets = Net Income / Total Assets

ROA is an essential metric for understanding how effectively your business uses total assets to generate profit. If your business has invested in machinery, vehicles, and other expensive equipment, the ROA ratio will help you figure out how much these investments add to the bottom line.

The ratio indicates the percentage of earnings generated for every dollar of assets on the books. If a toy manufacturer reports $25,000 in net income and $100,000 in total assets, the return on assets will equal $0.25 or 25%. In general, a healthy business should show an improving trend of ROA over past accounting periods.

Run the “Balance Sheet Detail” report to extract your total assets. If your total assets fluctuate frequently, it is best practice to average the total over multiple accounting periods. Next, run the “Profit & Loss” report to find your net income. Divide net income by total assets to determine your return on assets. The higher the number, the more profitably your assets are being utilized.
Average Collection Period

Average Collection Period = Accounts Receivable / (Annual Credit Sales / 365)

Are your credit customers paying you back in a timely manner? Small businesses often make the mistake of neglecting overdue AR balances and overall business efficiency suffers as a result. The average collection period ratio is an excellent starting point to make improvements to account collection procedures.

Run the “Balance Sheet Detail” report to find total accounts receivable. Finding the annual credit sales in QuickBooks requires a custom report. Generate a custom transaction report and filter it by the transaction type. Make sure to exclude any payments that were not made on credit. When you find the total annual credit sales, divide the figure by 365 to obtain the daily average. Finally, divide AR by this figure to obtain the average collection period as measured in calendar days. If your credit terms are NET30, but your average collection period is 45 days, this should be a major cause for concern. If the collection period is only 15 days, you can give yourself a pat on the back!