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15 Key Small Business Financial Ratios to Track
How is your business performing? Your answer should be based on rock-solid data and figures. We get it. Crunching the numbers and using financial ratios isn’t the exciting part of your business. Yet it’s necessary to ensure your business is financially healthy. You don’t want to grow in darkness and shoot aimlessly if you desire to grow and expand.
Financial ratios commonly fall into four categories: Profitability, Liquidity, Debt, and Operational Efficiency. Let’s dive deeper into the common ratios in these groups. These financial ratios can give you vital indicators about the health of your business.
Profitability Ratios
These ratios show your company’s ability to bring in profit:
1. Gross Profit Margin
Gross profit margin determines the profit you’re left with after paying the cost of goods (and not other expenses). The ratio indicates if your average markup on your items is sufficient. You want to remain with enough money to deal with expenses and still make a profit.
Gross profit margin = (Sales- Cost of Goods Sold) ÷ Sales = Gross Profits ÷ Sales
2. Net Profit Margin
The net profit margin is the percentage of sales remaining after you’ve paid all expenses, taxes, and the cost of goods or services. It’s among the KPIs that indicate whether or not your business is on the right path to success.
Net Profit Margin = Net Profits After Taxes ÷ Sales
3. Operating Profit Margin
Operating profit margins determine how efficiently you manage and control costs in your company. The higher the ratio, the better the cost controls.
Operating Profit Margin = (Gross Profit – Operating Expenses) ÷ Sales x 100
4. Return on Equity
Return on Equity determines the rate of return investors receive from an investment after taxes.
Return on Equity = Net Profit ÷ Shareholder’s Equity
Debt Ratios
These ratios indicate how your firm uses debt to ensure operations are running effectively.
1. Debt to Asset Ratio
The debt to asset ratio is the percentage of your total assets funded by your creditors. That means you could be in trouble if the ratio is high.
Debt Ratio= Total Liabilities ÷ Total Assets
2. Debt to Equity Ratio
The debt to equity ratio indicates your business’ ability to settle loans. It’s the percentage of your liabilities covered by your shareholder’s Equity.
Debt to Equity Ratio = Total Liabilities ÷ Shareholder’s Equity
3. Times Interest Earned Ratio
The times interest earned ratio determines your business’s ability to settle contractual interest payments. An attractive ratio shows your business’ ability to pay the interest.
Times Interest Earned= Earnings Before Interest & Taxes ÷ Interest
Liquidity Ratios
Liquidity ratios indicate your company’s ability to meet short-term debt obligations without raising extra capital.
1. Operating Cash Flow Ratio
This ratio indicates your business operations’ cash flow to its current debt. It indicates how liquid your business is in the short term because it links cash flow with its current debt.
Operating Cash Flow Ratio = Cash Flow From Operations ÷ Current Liabilities
If the ratio is below 1, your business lacks enough cash flow to settle its short-term debt. It could indicate that you might be unable to continue operating.
2. Current Ratio
The current ratio shows whether or not your business can settle its short-term (or current) liabilities. It’s more accurate if the inventory is liquid.
Since current assets and liabilities are short-term, you expect to turn those assets into cash and pay off those liabilities within a year.
Current Ratio = Current Assets ÷ Current Liabilities
3. Quick Ratio
Also known as an “acid test,” a quick ratio is similar to the current ratio but excludes inventory. The ratio is a good indicator in instances where it’s hard to convert inventory into cash. While a ratio of 1 is recommended, the figure varies by industry.
Quick Ratio = (Current Assets – Inventory) ÷ Current Liabilities
Operational Efficiency Ratios
Operational efficiency ratios shine a light on your firm’s primary activities. You determine them using data from your income statement and balance sheet.
1. Inventory Turnover
The inventory turnover ratio points out how your business turns inventory into cash.
Inventory Turnover = Cost of Goods Sold ÷ Average Inventory
To get the average inventory, add a specific period’s inventory balance to the previous period’s inventory balance and divide the result by 2. The period can be a quarter, for example.
2. Accounts Receivable Turnover
Accounts receivable turnover indicates how you’re managing your collections. A high figure usually shows that clients are settling their debts quickly.
Accounts Receivable Turnover = Net Annual Credit Sales ÷ Average Accounts Receivable
To determine average accounts receivable, add starting to ending receivables over a period and divide by 2.
3. Revenue Per Employee
You need to know your employees’ efficiency and productivity levels. A revenue per employee ratio helps you ensure that you’re managing your workforce efficiently. And benchmarking the figure against similar firms is recommended.
Revenue Per Employee = Annual Revenue ÷ Average Number of Employees in the Same Year
4. Return on Total Assets
This ratio points to how efficient your business assets are in generating profits.
Return on Total Assets = Net Income ÷ Average Total Assets
To determine average total assets, take the sum of starting and ending assets over the year and divide it by 2.
5. Average Collection (or Debtor Days)
Average collection approximates the duration it takes for your clients to meet their obligations.
Average Collection = 365 X (Accounts Receivable Turnover Ratio ÷ Net Credit Sales)
Where net credit sales= Sales –Sales returns- sales allowances
Let Visory Handle the Calculations
Financial ratios reveal a snapshot of your business, helping you understand its health at a particular point in time. You (the business owner), lenders, and investors want to look at those figures to make decisions. That’s why you need to crunch those numbers.
But if your plate is already packed full with other equally crucial tasks, you need a helping hand. That’s where Visory steps in.
It’s time to dump daily spreadsheets. Bring Visory’s team of experts to manage and streamline your bookkeeping, payroll, reporting, and account tasks so you can return to big-picture business growth.
