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Balance sheet ratios explained for clients

Owners often skip the Balance Sheet. Two or three ratios, explained once and then reported every month, make it useful: they show whether the business can pay its bills and how it is financed.

Working capital

Current assets − current liabilities. Current assets are cash and items expected to turn into cash within a year (receivables, inventory, prepaid expenses). Current liabilities are amounts due within a year (accounts payable, credit cards, sales tax, payroll liabilities, the current part of loans).

Example: current assets $71,600, current liabilities $18,700 → working capital $52,900.

Current ratio

Current assets ÷ current liabilities. In the example, 71,600 ÷ 18,700 = 3.8. A ratio above 1 means short-term assets exceed short-term obligations. A very high ratio can also mean idle cash or slow-moving inventory, so look at what makes up the assets.

Quick ratio

(Cash + accounts receivable) ÷ current liabilities. It leaves out inventory and prepaid items, which can't always be turned into cash quickly. For businesses that carry stock, the gap between the current and quick ratio shows how much depends on selling inventory.

Debt-to-equity

Total liabilities ÷ total equity. It shows how much of the business is financed by creditors compared with the owners. It isn't meaningful when equity is negative; say so instead of printing a number.

Caveats worth mentioning

• Ratios are only as good as the Balance Sheet: unreconciled bank accounts, old receivables or missing payables distort them.
• Credit cards and lines of credit are usually current liabilities even if the owner thinks of them as long-term funding.
• Loan balances that are due within 12 months may need to be split between current and long-term liabilities; small-business books often don't do this.
• One month-end is a snapshot. Show the trend in cash and the current ratio over several months.

How to report them

Put cash, the current ratio and the quick ratio on the key-figures page with a one-line definition under each, and mention them in the commentary only when they move noticeably.