Financial Ratios

While not an all-inclusive list, the following ratios are often used during benchmarking by the construction industry, which are interpreted by the Construction Financial Management Association’s Construction Industry Annual Financial Survey:

Liquidity ratios measure a company’s ability to repay its outstanding short-term obligations out of its short-term assets.

• Current ratio equals current assets divided by current liabilities. In the current recessed economy, banks or sureties generally require a higher current ratio to provide a cushion to withstand unexpected conditions.
• Working-capital-turnover ratio is a product of total revenues divided by working capital (the net of current assets minus current liabilities) and indicates the amount of revenue being generated by the available working capital. A ratio exceeding 30 may indicate a need for additional working capital to support future revenues.

 

Profitability ratios measure a company’s ability to generate cash flows relative to various metrics during a specific period.

• Return on assets equals annual net earnings before income taxes divided by total assets. It's displayed as a percentage, and the higher the number, the more effectively a company is converting its assets into earnings.
• Return on equity equals the annual net earnings before income taxes divided by total equity. A high ratio may indicate either undercapitalization or a very profitable company. Low returns may indicate a conservative managerial approach or substandard performance.

 

Leverage ratios measure a company’s ability to meet its long-term debt obligations.

• Debt to equity equals total liabilities divided by total equity. The higher the ratio is, the greater the risk the creditors are assuming. Generally, a ratio of 3 or lower is considered acceptable.
• Revenue to equity equals annual revenue divided by total equity. A low ratio may be indicative of a conservative approach to obtaining contract work. Generally, a ratio of 15 or lower is considered acceptable.

 

Credit management

• Days in accounts receivable is calculated by dividing average net accounts receivable, excluding retention receivable, by annual revenues and multiplying the result by 360 days.