Thought we need to understand lots of financial before we find out what the business is worth but these basic ratio gives a very good idea about the business condition.

The more we do our due diligence in a professional manner, lesser the surprise we will have to face after its acquisition. We have to think like a man of action and act like a man of thought.

We begin by looking into-

Working Capital = Total Current Assets - Total Current Liabilities.

Working capital simply shows whether a company is making or losing money.  If a company is losing money it is very important to go further in the books and figure out what is happening, it should be treated as a red flag. On the other hand if it has a positive working capital try to see how long the company can remain a going concern based on its current performance.

Current Ratio = Total Current Assets/Total Current Liabilities.

The current ratio measures financial strength in terms of assets. It is a good measure of its solvency. What is a comfortable current ratio depends on the kind of business but in most of the cases it should be two or more. A very high current ratio might mean that cash on hand is not being used efficiently.

Quick Ratio = (Current Assets - Inventory)/Current Liabilities.

The quick ratio measures a company's liquidity by looking only at a company's most liquid assets and dividing them by current liabilities. It helps determine whether a business can meet its obligations in difficult times. Quick assets are cash, stocks and bonds, and accounts receivable. It does not include inventory. In general terms a Quick ratios in the range of  .50 and 1.0 are usually considered satisfactory if receivables collection is not expected to slow.

Debt/Worth Ratio = Total Liabilities/Net Worth.


Debt/worth ratio indicates a company's solvency. It is a measure of how dependent a company is on borrowing rather than equity. A very debt is dangerous of the company. Again the effect of interest rates can have a huge impact on the borrowing capacity of the company.

By looking at a these ratios we know what is actually happening in the business. It gives an idea what measure we need to take to improve the business and whether it is yes, no, and too tough to understand.

Robin C. Trehan is an industry consultant in the field of mergers and acquisitions. He can be reached at robin@tafunds.com