Financial metrics are the key numbers that you can focus on in financial statements.
There are three financial statements, the balance sheet, the income statement and the cash flow that we like to look at to find important metrics.
Were going to look at some of the most important financial metrics that you as investors can use to evaluate a company.
The first important number we look at on the balance sheet is liquidity.
Can the company you’re looking at really cover everything that they need to cover in the next year?
Or have they somehow overloaded themselves with short term debt and obligations that they could really run out of cash in the next year?
In order to evaluate this, we want to look at the current ratio.
Essentially it is a measure of working capital.
It compares the current assets, which are assets that can be turned into cash in the next year, with current liabilities, which are obligations that have to be paid in the next year.
What you want to look for when evaluating a company is a 2:1 ratio of liquidity to debt.
Some companies are very well run that have a lower ratios than that, because they are controlling their cash very well, or they are in an industry that isn’t growing fast so they don’t need as much liquidity.
These companies work their capital down so they don’t need as much cash on hand all the time and they can give that money to their shareholders.
You will know that these companies are very well run because, they are really big companies.
Most companies, particularly smaller companies need at least a 2:1 ratio between current assets and current liabilities.
That’s a great measure of liquidity. We call that the liquidity metric.