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Evaluating a potential subcontractor is an important step. Knowing about their health and circumstances is crucial for the business agreement. These standard financial ratios will help you and your risk management team evaluate your potential trade partner. They allow you to gauge the subcontractor's health and will enable you to make more informed decisions. When assessing a subcontractor, here are the top financial ratios to consider.
1. Liquidity
Liquidity ratios ensure that the firm has the ability to pay off its obligations as they come due. When applying for a loan, creditors pay attention to liquidity ratios.
Quick Ratio and Current Ratio
The Quick Ratio, also called the "Acid Test" ratio, is a liquidity metric. It is used to indicate the potential subcontractor's cash position. A higher ratio indicates a stronger position. You can get the ratio by adding the potential subcontractor's cash and cash equivalents, marketable securities, and accounts receivables or current abilities. The Current Ratio measures a company's ability to pay off short-term liabilities with the existing assets. A higher ratio shows substantial capital.
Underbillings to Working Capital
Underbillings to Working Capital represent the subcontracting company's working capital made up of performed work that is not yet billed. You get this capital by dividing the company's under billings by its working capital. A company with a lower ratio is better and preferred because under billings may be unreliable assets.
Days of Cash on Hand
Days of Cash on Hand refers to the number of days the company can keep paying its operating expenses with the available amount of cash without considering any additional revenue. A financially stable company has a high value, showing a solid cash position and the ability to withstand any constraints to its cash flow.
2. Turnover
Turnover is the total amount of business bills to clients minus discounts and taxes. Turnover includes any expenses and shipping billed to the client.
Account receivable turnover
This turnover refers to an activity ratio that measures how efficient a company is in using its assets. A low ratio shows that the company has a weak ability to collect on this turnover. In contrast, a higher ratio indicates that it has a stronger ability to collect on the turnover.
Working capital turnover
This turnover compares the generation of sales to the depletion of working capital over a given period. The turnover provides further insight into how the company uses its working capital to generate more sales.
Asset turnover ratio
The asset turnover ratio shows the efficiency with which a company deploys its assets to generate more revenue. It is achieved by considering the revenue over the total assets.
3. Debt
It is crucial to manage debt in the construction business. The following ratios allow you to see how debts and investments are being balanced by the subcontractor.
Debt ratio
This ratio measures the reach of a company's leverage. You can use the ratio to determine how much of the company's assets are financed by debt. A low ratio company shows that it is not primarily dependent on its debts, which is preferable.
Debt-to-Equity
The debt-to-equity compares how much the company's shareholders have committed to the company to how much its creditors, suppliers, and lenders have committed. A lower ratio is better and shows a financially stable company.
4. Profitability
If you want to know whether a particular contract will be profitable, you have to calculate the potential profits using profitability ratios. These ratios demonstrate the potential for a contract or your business to generate profit.
Gross profit margin
It indicates the company's revenue less the cost of sales (gross profit) as a percentage of its overall revenue.
Return on assets
Measures how effectively the company uses its assets to generate a net profit. It focuses on the net income and the total assets.
Net profit margin
This indicates the company's revenue less its cost of sales plus all operating expenses, taxes, dividends, and interest (net profit) as a percentage of its overall revenue
Final Thoughts
These financial ratios ensure that accounts are stable and without any unwanted or undetected deficits. They enable you to avoid unprofitable contracts and instead engage with subcontractors that enhance the growth of your firm and the success of your projects.
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