Key financial measures to plan for success

Financial ratio tracking for success

In this article you will learn about:

• What financial ratios are

• How keeping track of key financial ratios can help your business be more successful

• Which financial ratios to keep track of

Trying to understand financial statements can be overwhelming and confusing. In this article we will be unpacking what financial ratios are and how you can use them to better manage your business. Key words can be referenced in the glossary at the end of this article.

In a nutshell, financial ratios help you to make sense of the numbers included on your financial statement. They help you to focus on different aspects of your business: cash flow, efficiency and profit, for example. They can be used to identify trends, compare your business to competitors and help you to measure progress on the goals you have set.

Financial ratios you should be tracking in your small business

While there are many ratio’s these are the ones you need to be keeping an eye on.

Cash flow to debt = Cashflow from business operations ÷ total debt

Cash flow is often one of the biggest challenges a small business faces. This is why this ratio is an important one to keep an eye on. Debt does not feature as a liquidity problem until its due date. As long as you are making regular payments on your debt, it does not translate into a liquidity problem. Debt becomes a problem when there is a big repayment due and you don’t have sufficient money to repay it. When doing your cash flow planning, don’t forget to factor in your debt repayments as this not only affects your business operations, but can affect your credit profile too.

Net profit margin = (total revenue – total expenses) ÷ total revenue

Net profit margin is the percentage of your revenue that remains after you have subtracted all operating expenses, interest and tax. Investors and loan providers will look at your net profit margin because it tells them how successful your business is at managing costs and turning revenue into profit. A low profit margin is a sign of a problem while a high profit margin shows you are pricing your products correctly and practicing good cost control.

Gross margin ratio= (sales – cost of goods sold) ÷ by total sales

This is a ratio you should pay attention to if your business sells products. What this ratio reveals is how much money you have left once you have paid for the product and operating expenses (marketing, salaries, rent). The higher your gross margin, the healthier your business is. A low gross margin shows that you may have trouble paying your operating expenses.

Accounts receivable turnover = (total accounts receivable outstanding ÷ total sales) x number of days

This ratio measure how quickly you are being paid once a sale has been made. Being paid quickly makes a big difference to a small business. If it taking a long time to be paid it is perhaps time to start working on getting paid faster. Consider offering early settlement benefits such as discounts or other value ads to persuade customers to settle within your ideal payment days.

Sales per employee ratio = annual revenue ÷ number of employees

This ratio reveals how expensive it is to run your business and is a good metric to keep an eye on as your business grows. Businesses with a high sales-per-employee ratio are efficient when it comes to using people resources. While all employees may not perform a direct sale function, making this ratio a goal for all staff could foster better collaboration to help increase sales. Consider an incentivising staff to increase the sales per employee ratio by 10% in the next quarter as one of your SMART goals.

A final thought

To make the most of financial ratios, track and compare them over time in order to see the trends that emerge. Make time to regularly look at your ratios so that you can assess the health of your business. If the financial side of your business intimidates you, and you don’t have an in house account, we recommend reaching out to experts in this space that can help you make sense of how your business is doing.

Key Takeouts

Regularly assessing your business’ financial ratios can help you to keep track of how well your business is doing – and make adjustments where necessary so that you are in a better position to get through tough times.

Glossary

Financial ratios: help business owners to make sense of the numbers included on your financial statement

Accounts receivable: how much money a business is owed by customers for goods and services they have received, but not yet paid for

Annual revenue: the amount of money a business makes during a given 12-month period from the sale of products and services

Cash flow: the amount of money going into and out of the business

Debt: the money that is owed or due

Depreciation: a reduction in the value of an asset over time, usually due to wear and tear

Gross margin: this is way of measuring a business’ profitability. It looks at the business’ gross profit compared to its revenue or sales and is expressed as a percentage

Gross profit: the total sales of the business minus the total cost of the goods sold

Net profit: the amount of money the business earns after deducting all operating, interest and tax expenses over a particular period of time

Net profit margin: this measures how much net income or profit is generated as a percentage of revenue

Operating expenses: expenses the business incurs through normal business operations. These include rent, equipment, inventory costs, marketing, payroll, insurance and budget allocated for research and development

Liquidity: the ability to convert assets to cash or acquire cash – either by selling assets or through a loan

Total expenses: how much the business is spending before its net income

Total revenue: the amount of money the business make from selling its goods and services before considering expenses

Take action by setting SMART goals for your business or use these ratios to help you apply for a business loan.