PayTraq Blog

Green Light

Posted in business, financial analysis, accounting

In this article, we will focus on the main PayTraq dashboard, financial indicators and methods of their calculation and evaluation.

The main documents used in accounting are the balance sheet and profit and loss statement. These two documents are the basis for analysis and business planning.

First of all, let us explain what a balance sheet and profit and loss calculation are:

A balance sheet is a financial statement that summarizes a company's assets, liabilities and shareholders' equity at a specific point in time. An asset is something that is owned by a company, such as property, equipment, inventories, cash balance and accounts receivable. A liability is a source of funds for a company, includes chartered capital, retained profit and debts.

Profit or loss statement is a summary of income and expenditure items of an enterprise during the accounting period. The profit or loss for the accounting period is a sum of all items.

There are many different methods for the balance sheet analysis and profit and loss calculation in practice, but here we will concentrate on two of those methods:

The first is a vertical, or structural, method of the balance analysis when the proportion of each item in the total balance is studied. The second is a horizontal method when the dynamics of the balance sheet items compared to previous periods is analyzed.

You can also calculate the number of different indicators and factors characterizing the financial condition of the enterprise on the basis of these documents. All this together is called the financial analysis. Thus, the source of information for the financial indicators analysis of an enterprise is defined.

There are four indicators for the financial analysis with their normal values in PayTraq at the main dashboards. A charts of revenue, gross profit and earnings before interest and taxes (EBIT) for the last six months are here as well.

Now, let's find out about indicators themselves. Let us try to understand what these figures indicate and why their colour should be green.

The first indicator is a Current Ratio (or Liquidity Ratio). To calculate it, we need to take the current assets from the balance and current liabilities. Current assets are funds of an enterprise that generate revenues one or more times during the year. These include stocks, debtors and cash. Current liabilities are a borrowed capital, which must be repaid within a year.

The ratio of the current assets to the current liabilities is the Current Ratio. This ratio indicates whether the enterprise has sufficient assets that can be used to repay short-term obligations. In practice, the value of the indicator should be in the range from 1.5 to 3. If the index does not reach the lower limit, then the company has no assets to pay off short-term lenders and is liable to bankruptcy. Exceeding the upper limit indicates the irrational structure of assets; in other words, the current assets do not work and remain useless.

The second indicator is an Equity Ratio. The equity ratio is an investment leverage that measures the amount of assets that are financed by owners' investments by comparing the total equity in the company to the total assets. To calculate it, we need to take the equity capital, which consists of share capital and retained profit from the balance and divide it by assets. The indicator shows the share of assets formed out of their own capital.

The lower the figure, the greater the property was purchased at the expense of the borrowed capital, the higher the dependence on creditors and the less financially secure. The recommended value of the indicator should be in the range from 0.5 to 1.

The third indicator is a Debt-to-Equity Ratio or financial leverage. To calculate it, we need to take all the borrowed capital of long-term and short-term creditors from the balance sheet and divide it by the equity. This indicator measures the degree to which the assets of the business are financed by the debts and the shareholders' equity of a business; in other words, how much profit the enterprise has received by attracting debt capital.

If the value of the indicator is great, then the enterprise loses its financial independence, and it is more difficult for them to raise additional borrowed capital. If the value of the indicator is low, then there is lost opportunity to use financial leverage – to increase the return on equity at the expense of the borrowed funds involvement in the activities. The optimum value of the indicator is from 1 to 2.

The fourth indicator is an Average Return on Sales. To calculate this ratio we need two numbers from profit and loss statement, take the gross margin from sales (gross profit) and divide it by turnover (sales). The indicator tells us how much gross profit we get from one sale. For enterprises operating at a profit rate, the indicator must be greater than zero.

Summary: If the dashboard numbers colored green, the financial indicators are normal, and your business is all right; keep moving forward.