Okay, we should have the ratio analysis worksheet out now. And what we're going to do is go through all 14 ratios. This is taking a deeper dive This is the financial analysis that a lot of bankers will do a lot of investors will do To test the health of the organization. how we're going to do that is by looking at, you know, solvency, efficiency safety ratios. And we're going to start off with the solvency ratios. This is about how fast do we convert our assets into cash.

These are broken out into timeframes. When we think about current ratio, we're talking about, what can I convert to cash within a year, that's our current assets. So all your current current assets should be included into this because they should be able to become cash within one year. The next step down is the quick ratio. This is the 90 day timeframe. What can I really convert to cash within 90 days without discounting it right.

So that's one of the reasons Why they leave inventory out of the quick ratio is that generally in order to sell all your inventory, you have to discount it. So think about quick ratio as a 90 day part, right? I mean, can't What can I convert to cash in 90 days? So that's kind of the difference. The other one is the cash ratio, which we won't go over today. But cash ratio is what can I get this month?

Right? What can I convert to cash this month? So but let's think about the current ratio and the quick ratio, the current ratio, we're going to go to the balance sheet, we're looking at year five, and his current assets were about $2,000,049. With current liabilities about 1.5 million. When I think about that, we've got 2 million divided by 1.5 million gives us a 1.35. Yeah, I got 1.35 Well, doesn't mean anything, right.

So because ratios don't mean anything unless you compare them to something else. So when we look at the industry averages that I given you, in the shaded boxes is a number one that number one corresponds to current rate So you see, there's a number one by current, there's a number two by quick, the shaded boxes will help you find which ones we're actually evaluating. So in this case, sammys company spectrum manufacturing has a current ratio of 1.35. Now, to explain it, I'm going to give you an example of each a current liability, a good example would be a credit card, a current asset. A good example of that would be your checking account. So when I see 1.35, here's what I think.

For every dollar I own the credit card I have $1 35 to pay for it makes it make a little bit more sense to me. So for every dollar, I will get $1 35 to pay for it was that good, fair, terrible. Again, I don't know because I'm not comparing it to anything else. At this point time. What a new nose I at least can hold my own. I at least have $1.

So for every dollar I owe, I at least have $1 35 which means I should be able to pay off my current liabilities within the next 12 months. But when I compare it to the industry, everyone else and pay Manufacturing has $1 90 Alright, so now it looks a little bit differently. Even though I can hold my own. When I compare myself to everyone else, they have $1 90 to pay for every dollar and liabilities that they have. Remember what I said in lesson one, then I like this number to be two. That's what you should be looking at two, it should be a two or at least comparable to the industry average, such a current ratio.

The second one is the quick ratio. And the quick ratio again, what can I convert in 90 days, I'm going to leave inventory out, I'm gonna leave prepaid expenses out because chances are, you're not going to get that money back from a prepaid expense. So really those types of things out. So when I compare it, I've got cash now plus receivables that's the big ones. So I got 739,000. I'm gonna divide that by the same number of current liabilities, the 1.5 million.

And when I do that, I get a quick ratio of point four nine. Yeah, point four nine. So I'm now means in 90 days for every dollar I own the credit card can only get my hands on 49 cents. That means two things. A, I can't cover my current liabilities, B, I dropped out my inventory. I'm heavily dependent on inventory, look at the change, I can make my current liabilities in a year with inventory in, but I can't do it in 90 days without the inventory.

So there's a heavy dependency there in the relationship on the quick ratio from the current ratio. When I compare this to the industry, everyone else has $1 10. So they have $1 10 to pay for their liabilities, we only have 49 cents. This is also showing risk, right? Because if your company actually goes belly up, who's gonna eat that 51 cents in debt? Yeah, whoever's carrying the debt.

So this is actually showing some risk as well inside your company. So your quick ratio, it changes a lot changes pretty fast, but it's one that's going to give you an indication of what can happen in the next 90 days. All right, the next One we've already done debt to equity is one of our eyes. It's one that I manage pretty closely. And we we did his, it was 2 million divided by 1.4 million, and gave us a 1.45. So we said that was good because we want to be at a 2.5 or less, he's at 1.45 or less, and we would compare it to industry, the industries that are 1.3.

So for every dollar our competitors put into their companies, they let the bank put in 1.3 or $1 30. Or we would let the bank put in $1 45. It's pretty close. It's in the ballpark, I would say this is actually fair. He's doing okay here in line with his competitors. And he's still below 2.5, which is what we're going to be looking for from a debt or leverage standpoint.

So those are your first three. Moving on down, we go to more efficiency type ratios. One being the gross profit margin, remember, this is really important. Gross Profit is really important. That's the one I'm going to keep counting on, as you should know, your gross profit number. In his case he had 2.1 million, and on sales is 7.1 million, which gives him a gross profit margin of 30.7.

The industry is running at about 32%. He's about 1%. Lower, he's still in the ballpark, I consider this fair. What we're going to figure out next is, is it good enough? Right? Remember, the industry average is just that.

It's just an average. That's the C players, we want to be a and b player. So always look at in industry averages where you want to be at the lowest point, because then we want to improve upon that from a net profit perspective, which means after we've already went down the line, now we're looking at net profit. We only made $11,000 before tax on $7 million in sales, which gives us a net profit margin of point one 5%. So less than 1% less than less than half a percent less than a quarter percent. I mean, this is what I call practice and working right because he's not doing it.

For money, he's almost doing it for no money. So almost a breakeven business, he's not losing money. But that's a lot of work $7 million worth of work to just bring home $11,000 in the industry, they bring home at least 3%. Right on average. So we've got a lot of room for improvement, just right here. And we can see that, you know, we're running in about the right area for gross profit.

We're way below on net profit, which tells me I have a problem and operating expense. And we know that from the expense control, I fi right, he needs to cut about $100,000 in expense. This is further proof that that's true. Okay, return on assets. A lot of people don't know what this means. First of all, the only reason to buy assets, the only reason is to generate revenue and profit.

That's it. You shouldn't buy things unless you're not going to do that with it. People say well, what about the training table? Well, you're actually training your people your training, you know, folks to be more productive, more efficient in your business and they They're supposed to, in turn, create sales generate profit. So investing in things that actually help your workforce or help you do things more efficiently is exactly what you're supposed to do. buying things just to reduce taxes, probably not the best idea unless you're also going to increase revenue or profit with it.

In this case, we're looking at every dollar that you invest in an asset, how much of that dollar comes back to you in the form of profit. That's what this ratio is going to tell you. What's the return, I get the profit I get on the assets that I buy? Well, we had net profit of 11,000. We have total assets of 3.5 million, almost 3.6 million. I guess it's the return of a third of a percent.

Right point three, one. We're not generating revenue and profit very good with our assets. This is saying that we're under utilizing it, especially when everyone else in the industry is getting 8%. We're getting a third of a penny. I mean, it doesn't make sense. We would do that.

So if you see this, you saying, Oh, I might have too much in assets, or underutilized what I have, maybe it's too much capacity for the value I'm putting through it. So look at this as a metric of whether or not you're using the assets properly. And if you have too much assets, and you have a cash problem, maybe you need to sell some of the assets and put some cash into the business. The next one is return on investment, which we usually use to compare. What else could I do with my money? Right, should I put in a CD, a bank account, the stock market or into a business?

In our case, with spectrum manufacturing, we made $11,000. And we've invested about 1.4 million in our equity section, which gives us a return of less than 1%. Yeah, less than 1% return on investment. So think about that mean we might have back in 1960 when this company was formed. Maybe if I take the money and put it in the ground, there'd be more valuable In just the coins, or the dollars that are ahead in the ground that we're actually making on this company right now it's less than 1%, especially when everyone else is making 16% on their money. So think about that when you're buying companies, what should I expect?

So if I want to go buy a company like spectrum manufacturing, I shouldn't be expecting running it properly, to make about 16% on their money. That's one of the ways you can make decisions on what you should do versus what you shouldn't. And in this case, we know we're having a poorly managed company that's not generating a lot of profit at this point in time. Okay, carry it now, sales to assets, sales data assets. super interesting, right? Because this is going to give you an indication of how much additional revenue you can expect from an investment in a piece of equipment.

This is what you're already doing. So we're measuring your company, how many sales or how much in sales Do you generate already with the amount that you've invested in, in your equipment, your assets. So in this case, we do about $7 million a year. We have assets of About 3.6 million, which means we're generating about $1 98, which means for every dollar I put into a piece of equipment, I should expect $1 and 98 cents back. Now compared to the industry, everyone else is about 2.3. You see, we're almost in the ballpark, we're just a little behind.

So that's important to know you're just a little bit behind. But everyone else use their assets a little bit more efficiently, and they generate more cash to generate more sales. So that's something to look at. We have underutilized equipment. The next six are all part of the working capital cycle. In lesson two, when we talked about the speed of cash, we talked about the result, how do I use the result days the turnover days of inventory, work?

Accounts receivable and accounts payable? This is how you calculate it. First of all, we're gonna take inventory turnover, just to say how many times do I have to replace a piece of inventory per year. So I take my cost of goods sold, which is, you know, it's the inventory asset. But when I sell it becomes Cost of Goods Sold expense out of inventory. And when I divide inventory by cost of goods sold, I get a turnover rate of 4.04 times where everyone else is turning over five times.

That means it means I have to replace inventory four times a year. So if I had something sitting on the shelf, that me somebody would buy it four times a year and I'd have to replace it as baseboard, you know, I'm bringing it down to one piece. So I had to replace it four times a year doesn't sound that great, especially when your competitors have to replace there's five times a year. This is a number that you want to move fast and when it moves fast that means the number is higher, right. And one way to easily look at it is converted to days. So in this case, I take 365 days and divide the turnover by and I come up with 90 days.

So 365 divided by 4.04 is mean 90 days. That means my product sits on the shelf for 90 days before someone buys it by competitors, it only sits there 66 days. Super important because you don't want your money to be sitting on that shelf. It's just dead money. You've already bought inventory. It's sitting there, it's not doing anything for you unless it's in someone else's hands.

This is also a good way to determine how much inventory you should have. Right? And we're going to be doing that next is what's the right amount of inventory I should have based on the industry average and the comparisons. So that's one of the one of the primary components of the working capital cycle is turnover days. And this company has 90 days worth of inventory. The next two, AR and AP, these are your best tools to fight short term cashflow problems, the best tools you have.

And I say I'm gonna tell you this right up front, run these around the industry average. If you don't, you take away some of your best tools, and I'll explain Accounts Receivable turnover This is measuring how well do your customers like you that they're willing to pay you, right? How fast do they pay you? So we take our sales and how much we're owed 7 million. And we're currently owed 650,000, which means we're turning over our accounts receivable we're getting paid 11 times a year, our competitors only get paid eight times a year. That's how you can read that I get paid 11 times a year, our competitors only get paid eight times a year.

And when we convert that turnover rate to a day, it means I get paid every 34 days. They get paid every 44 days which one would rather be? Yeah, the one that's actually getting paid sooner, right? You're getting money sooner. This company actually is good at collecting. They'd like to make phone calls, right?

It's a double edged sword when I told you be around the industry average. It's because being too aggressive here might actually hurt your sales. Because your customers have a choice. Right? They can go to someone else if they can go to your competitor. Who actually gives them 44 days to pay when you're actually a little bit more aggressive?

Maybe you email them, then call them then send them a letter, then stop by their house. Wait, yeah, don't do any of that. But if you're too aggressive, people may change vendors, they might not use you anymore. So if you maintain the industry average, if you do run into a cash flow problem, you can make a few phone calls, collect a little money in sooner, and then lighten the backup. Alright, so you can use this as a way to catch money a little bit faster when you run into a cash flow surprise. The next one is accounts payable.

This is how well do you pay your vendors and again, stay next to the industry average. Otherwise, you might find yourself in a cash flow problem. Alright, so in our case, we've got our inventory out there and we owe $750,000. Right now, when I convert that to a turnover rate. That means I'm paying my vendors about six and a half times a year. Everyone else pays about 11 times a year.

Good or bad, your instinct might tell you that bad. In actuality, that's good. Now, it's good because we actually owe the money but we still have the money. Whereas our competitors, the money's already coming out. When I convert that to the turnover rate or today's, it means I'm paying my bills every 56 days, everyone else pays in 34 days, if you pay too quickly, you're taking cash out of your company and giving it to the vendors. If you pay too late, it can also hurt you, which means a vendor also has a choice.

They can put you on Cod, they can stop selling to you all together, they could actually, you might be missing out on discounts like the the most common one is 210. net 30. You get a 2% discount. If you pay in 10 days, otherwise terms or net 30. You could be missing out on cash discounts or real cash. And this case, we can see that they're stretching your payables out a little bit. Everyone else gets, you know, pays the vendors in about 34 days.

They're paying in 56 days. It could hurt them in the long run. So all the phone calls, they like to make up an AR, where they don't like the answer. I'm down here in AP. That's basically what's at what's happening there. But this is where you got to be careful.

That's why I say keep it around the industry average. And if you run into a cashflow problem, you can hold on to a bill for another week or two and then pay it back down. But use this as short term fixes on a cash flow problems. So there's your ratio analysis, we come up with some problems, we solve some problems. We saw some things that they're actually good at, like as they are, but let's dig deeper. Now.

Let's let's see what the financial impact is on how they run their business. What's the actual financial impact? So this is the financial impact worksheet. It's going to tell you that by running your business a certain way. Is it good for your money or bad for your money. This is like a place where you can find hidden cash and your own operation.

So I've got six different places I can look for cash. One is gross profit. So I take the sales I currently have, and I multiply it by what everybody else makes everyone else makes 32% that's the gross profit. So I should be making 2.2 million. But what I'm actually making is 2.1 million. So there's a financial impact to me of $100,000.

That 1% that we said was okay in the ballpark is actually worth $100,000. So if I can move my gross profit from that 30% 30.7% that it is to 32.2 that means $100,000 extra in my pocket. Incidentally, we were $100,000 short and net profit. If we already have expenses covered, every percent increase in gross profit goes right to the bottom line goes right that hundred thousand dollars would be right in our profit with a 1% bump. So in this case, I'd be looking for a way to bump up our gross profit by 1%. Then we look at net profit Net Profit is a result, we can't really do anything to it.

But it helps us gauge where we're at. So an average company makes more money, we barely make any money in this company. So we have 7 million in sales. If we made 3%, like the average company, we'd make $220,000 a year. But we're not average, we actually made $11,000 per year. That's a financial impact of $200,000.

Hmm, think about that. We have to also look at the things that that are part of the net profit and gross profit is one or short $100,000 by 1% bump. That means the other hundred thousand 209 minus 106 103,000 has to come from operating expenses. We already guessed that we were over on operating expenses by 100,000. This gives me an exact number I need to cut $103,000 out of operating expenses and add 1% to my gross profit and when I do have $200,000 in net profit, right there. We've just increased it with two moves.

From a sales standpoint, we already know we have underutilized equipment. So we have assets of about 3.6 million, and we should be turning it over at 2.3 times, which means for every dollar I put into equipment, it should be returning $2 and 30 cents. If I did, I'd be making 8.2 million in sales, not the 71 that I'm doing right now. 7.1 million. So that means from a sales standpoint, I'm short a million dollars 1.1 man, think about that. That means without another investment in a piece of equipment, I should be able to increase my sales at least $1.1 million before I hit a capacity problem.

This is Tony about what you should be operating at with the same equipment that your competitors have. You should be operating at about this level. 1.1 million more. Okay, the last one again, cash conversion. Working Capital cycle inventory. This is saying how much inventory should I have?

Right now we were doing about 4.9 million in cost of goods sold. If we were average, we'd be turning our inventory over more quickly or five times a year. And we should have if that's the case, $895,000 sitting on the shelf and inventory. We don't we have 1.2 million sitting on the shelf. So when we that's how much you want to know how much is too much. Well, in this case, we have $322,000 too much.

And I'm telling you, if you reduce your inventory from the 1.2, to the 888 hundred 95,000, you'll put $300,000 cash back into your pocket or back into the company. How because you're not replacing it, you're not taking it out of the company to replace it. You're just lowering the inventory levels. So you're keeping cash in the company. The last two accounts receivable and accounts payable. They're actually doing a good job here.

Were they behind on the other four on $7 million, they should be turning over the receivables eight times a year, and they should be owed currently $855,000. But they're only owed $650,000. So they have $200,000 $201,000 more money than their competitors. That's an important number to know that their collection practices actually brings in more money. Their problem is they have four other categories that actually Rob's money from the company by stretching their payables, it's about the same situation where they should owe $450,000 right now, they actually owe 750,000. So almost 300 $294,000 is more money to have in the company, even though they still owe it, they haven't paid it so the cash is still there.

So the combination of the good things are doing the AR and AP and the combination of the others that are not doing so well, such as gross profit and net profit in a inventory, the difference between the two is around $500,000. So this company could have $500,000 more in their pocket, just by changing these six things. So let's talk about how each thing affects each other. We already know we're $209,000, short of net profit from the average company. This is a cause and effect. So when I have $209,000, there are things that contribute to that.

One of the things that contributes to it is our poor expense control, and we find out that we had $103,000 a week to cut. If we did that $103,000 more goes down to the bottom line. And we also found out that we have $322,000 too much inventory. So on the high side, and we may have too much inventory, we also have high carrying cost, and we have high carrying costs, that contributes to your bottom line. And what that means is it costs a certain amount of money just to house inventory or have people touch it or reorder it, or put it in the system remove it from one place to the other. In this case, on average, it's around two 95% of your inventory.

So we have $323,000 is too much 25% of that is $80,000 in carrying costs that would go away if we just reduce our inventory. When you have too much inventory that's not moving very fast. And you have poor expense control, chances are you have Oh cash, and when you have low cash, you're gonna have more debt, and we have more debt, you're gonna have more interest, right? So if you're following the chart around, that's kind of what's happening. Little cash leads, the more debt more debt leads, the more interest or interest leads to less than that profit. Then, from an inventory standpoint, because of how we're paying, we're paying late or we're paying in 56 days, we might be missing out on the cash discount that 210 net 30 I described.

If we could get 2% of our inventory purchases back in cash. That's $98,000 we put back into the company. There's other things that contribute to low growth. profit, right? We said a 1% bump? Where would you find that?

Well, it might be a poor product mix, you might have stuff that's not moving very well, you might your pricing strategy might need a 1% bump to make this happen, you might need to renegotiate with some of your raw material vendors. The last thing I would look at is just it's a bookkeeping error, or it's going out the back door and shrinkage or breakage. But more importantly, more or less $106,000 in gross profit, one of these are contributing factors to increasing our gross profit. So we've got to look at. So overall, this is the cause and effect, we can point out some of the problems and when we outlined the problems, here's what I saw. I saw that we have low gross profit, and when you have low gross profit, you got to do things like raise your price.

We're gonna negotiate with your vendors somehow we need 1%. We also have poor expense control to the tune of about $100,000 we need to cut $100,000 out operating expense under our current sales value. We also have too much inventory when we have too much How much is it? It's $322,000, we need to clearance it when you discount it, we need to just get rid of it through attrition somehow get the inventory levels down. Because we know that we should only have about 895,000 we have 1.2 million. And lastly, we got a low sales value, right?

I mean, just we have underutilized equipment. It's not reaching this capacity. And we need to focus on things that bring in higher volumes of work for the equipment that we have, you know, on our manufacturing floor. So that was lesson number three ratio analysis. This is where we dug in and we kind of acted like a financial doctor, where we were testing it through ratio analysis, we were analyzing results by comparing it to the industry, we were diagnosing the problems and then coming up with a treatment treatment plan. We're almost like a financial doctor.

Right? That's the way you should view your financials. That's the way you should look at your company. And I'm going to challenge you right now to go right to cash flow tool. And let's build a Cash Flow dashboard that focuses on ratio analysis much the same way we just did over the last hour.