Financial Ratios

Dear M & M:

 

What are some financial ratios I should pay attention to as a business owner?

 

– Doug

Dear Doug:

There are many financial ratios that every business should monitor. Here are a few in no specific order. Inventory turnover: the number of days it takes to sell your inventory (the lower the number the better). The following two ratios are in the category under asset management. They are indicators how well you are managing your assets. The formula is inventory times 365 days divided by cost of goods sold.

The goal is to reduce excess inventory on hand not turning. A second financial ratio that is important to most businesses is accounts receivable turnover. It will show how many days it takes to collect money owed to you (once again the lower the number the better). The formula is accounts receivable times 365 days divided by net sales. The goal would be to reduce the number of days receivables are owed.  The next sets of financial ratios are called liquidity ratios.

They indicate how quickly you can return assets into cash. The first ratio under the liquidity ratio category is called working capital ratio. The formula is current assets minus current liabilities. This shows if a company has enough liquidity to operate on a daily basis (the higher the number the better).

The goal is to keep enough money on hand for daily operations. A second financial ratio under the liquidity category is called the current ratio (the answer should be at least 2 or more, meaning the company has at least twice as many assets as liabilities). The formula is total current assets divided by total current liabilities.

A third category of financial ratios is under the category of financial ratios called profitability ratios (the goal is to have a high number, the higher the better). The formula is net profit divided by net sales. To increase ones profitability ratio one would have to raise prices, lower the cost of goods sold and reduce expenses.

The numbers needed to calculate these financial ratios all come from your company’s income statements and balance sheets. Knowing where you are at in some of these areas will enable you to better operate your business. Comparing your financial ratios with industry comparisons as well as tracking your own company’s historical averages will go a long ways in making your company more sustainable.

If you need to get financial ratios for your industry contact Cochise College’s Small Business Development Center we have access to a data base called Profit Cents and we can pull up some financial ratios based on your company’s North American Industry Classification System (NAICS).

Call 520-515-5478 for a one-on-one appointment with a counselor to receive your “free” Profit Cents industry ratio analysis report. Other financial ratios included in the report are Direct Labor Ratios, Occupancy Rates, Profit per Employee, Gross Profit Margin, Debt to Equity, Advertising to Sales, Utilities, Interest Expense, EBITDA, Retained Earnings and many more.

– M&M

To ask your questions: Call the Small Business Development Center(SBDC) at Cochise College (520)-515-5478 or email schmittm@cochise.edu or contact the Sierra Vista Economic Development Foundation(EDF) at 520-458-6948 or email  hollism@svedf.org

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