A ratio divides one financial-statement number by another so that the result means something on its own. In BAF3M you met the current ratio, quick ratio, working capital, debt-to-equity and inventory turnover. Grade 12 analysis asks harder questions. How many days do customers take to pay? How long does a sweater sit on the shelf? Could the company keep paying its interest if profit fell by half? This lesson groups ratios by the question they answer. Liquidity: can the company pay what it owes in the next year? Efficiency: how quickly do receivables and inventory turn into cash? Solvency: can it survive and carry its debt over many years? All examples use Maple Outdoor Ltd.'s 2026 statements from the previous lesson.
Liquidity: can the company pay its short-term debts?
| Ratio | Formula | Maple 2026 | What it tells you |
|---|---|---|---|
| Working capital | Current assets - current liabilities | $250,000 - $110,000 = $140,000 | The dollar cushion left after paying all current liabilities. |
| Current ratio | Current assets / current liabilities | $250,000 / $110,000 = 2.27 | Dollars of current assets for every dollar due within a year. |
| Quick (acid-test) ratio | (Cash + short-term investments + receivables) / current liabilities | ($40,000 + $80,000) / $110,000 = 1.09 | Can bills be paid without selling inventory or using up prepaids? |
The quick ratio is stricter than the current ratio because it leaves out inventory and prepaid expenses: inventory must first be sold (and may sell at a discount), and prepaid expenses will never turn back into cash. A current ratio of about 1.5 to 2 and a quick ratio of about 1 are common benchmarks, but too high is not ideal either. A current ratio of 5 might mean cash sitting idle or inventory piling up. Grocery chains, which collect cash immediately and sell inventory fast, can operate safely with a current ratio below 1.
Efficiency: how fast do receivables and inventory turn into cash?
Turnover ratios divide a full year's activity (sales or cost of goods sold) by the average balance tied up during the year. Averages are used because the activity happened all year, while a balance sheet shows only one day. Average = (beginning balance + ending balance) ÷ 2. Ideally receivables turnover uses net credit sales; when credit sales are not reported separately, analysts use net sales, as we do here. Converting a turnover into days (365 ÷ turnover) makes it easier to picture.
| Ratio | Calculation for Maple 2026 | Result | Industry average |
|---|---|---|---|
| Average accounts receivable | ($70,000 + $80,000) / 2 | $75,000 | |
| Receivables turnover | $800,000 / $75,000 | 10.67 times | 9.0 times |
| Days' sales in receivables | 365 / 10.67 | 34.2 days | 40.6 days |
| Average inventory | ($100,000 + $120,000) / 2 | $110,000 | |
| Inventory turnover | $480,000 / $110,000 | 4.36 times | 4.8 times |
| Days in inventory | 365 / 4.3636 | 83.6 days | 76.0 days |
Maple collects from customers in about 34 days, faster than the industry's 41, which is good: cash comes in sooner and fewer accounts go bad. A useful test is to compare days' sales in receivables with the credit terms: if terms are net 30, an average of 34 days means most customers pay roughly on time. Inventory is the weak spot. Merchandise sits for about 84 days versus 76 for the industry, which ties up cash, raises storage costs and risks goods going out of style. This matches the horizontal-analysis warning that inventory grew faster than sales.
Solvency: can the company carry its debt in the long run?
| Ratio | Formula | Maple 2026 | Industry | What it tells you |
|---|---|---|---|---|
| Debt-to-equity | Total liabilities / total shareholders' equity | $310,000 / $390,000 = 0.79 | 1.00 | Dollars of creditor financing for every dollar of owner financing. |
| Debt ratio | Total liabilities / total assets | $310,000 / $700,000 = 44.3% | 50.0% | The share of assets financed by creditors. |
| Times interest earned | Income before interest and income tax / interest expense | $120,000 / $20,000 = 6.0 times | 4.5 times | How many times operating profit covers the interest bill. |
For times interest earned, start from income before income tax and add back interest expense: which equals operating income. The add-back matters because interest is paid before tax, so the earnings available to pay it are earnings before both. Maple's operating profit could fall by more than 80% before it could not cover its interest. Lenders often write a minimum times interest earned or a maximum debt-to-equity into loan agreements (covenants); breaking one can let the lender demand early repayment.