As a small business owner, it can be overwhelming when trying to review and understand your company’s financial statements. Luckily, there are several ratios that you can utilize to help better understand what the financial statements are trying to tell you. This article lays out several of the key management ratios that are used across various industries. These ratios can be calculated using information found from the balance sheet and income statement.
Some of the key balance sheet ratios include the following:
- Quick Ratio
- This ratio measures a company’s ability to pay off its current debt obligations without selling inventory.
- (Current Assets – Inventory)/Current Liabilities
- A quick ratio of 1.00 is considered to be average. The higher the ratio, the better liquidity a company has.
- Working Capital Ratio
- This ratio shows how much cash is available for daily operations.
- Current Assets – Current Liabilities
- Banks will compare this with the industry average; lower figures may indicate financial distress.
- Return on Assets
- This ratio shows how much net income is being generated by the assets of a business.
- Net Income/Average Total Assets
- Shows how much money the company is earning on its investment. The higher this number, the better.
In addition to the balance sheet ratios, several important ratios can be calculated using information found in the income statement. Some of those important ratios include:
- Gross Profit Margin
- This ratio shows how much money is left over after a company sells a product and pays for the cost of said product.
- (Sales – Cost of Goods Sold)/Sales
- Should be reasonably stable, but needs to compared with the industry average.
- Net Profit Margin
- This shows how much revenue remains after all expenses have been deducted from total revenue.
- Net Earnings/Total Revenue
- Investors want to see this margin rise over time.
It is also critical to consider non-financial related metrics when evaluating your business. Each company should identify “Key Performance Indicators,” or KPI’s, that are closely tied to the business’s success because they focus on the future, not historical information. They tend to be more predictive in nature and can be easier to measure in real-time. This allows a business to track their progress towards common goals, promotes efficiency and consistency of their work, and encourages a platform for future strategy creation.
TDT works with clients across varying industries in identifying their own KPI’s. Reach out to one of TDT’s team members if you would be interested in discussing your financial statement health and Key Performance Indicators.