Financial Ratios for Business Success


You can note and record your business performance in several ways using available data. Using financial ratios, you can quickly assess all areas where your business performance is excelling or underachieving. This way, you can judge where you need to improve in the areas you lack and where you need to retain and maintain the areas you have had success.

The other motive for using financial ratios in your business is that you can see and decide just how beneficial or disadvantageous it will be in one area if any such modifications are made. You can easily measure the effects of the changes elsewhere in another location.

Monitoring figures closely in your business will help you minimize waste and maximize efficiency, which will, in turn, grow and flourish your business over time.

Where do you get the information to calculate your financial ratios? Bookkeeping helps you provide all of the necessary and relevant information from which your accounts are formulated. The process of bookkeeping is recognized and well-defined in the fields of business and accounting.

Every transaction must be recorded, regardless of its nature (purchase or sale). The process of bookkeeping helps ensure accurate and timely records. Here are four ways to asses your business performance using financial ratios.

Complete Controller. America’s Bookkeeping ExpertsCurrent Ratio

The most regular and familiar ratio used is called the current ratio. This ratio calculates the ratio of current assets to the ratio of current liabilities. The current ratio is used to help specify a company’s potential and capacity to pay off its short-term invoices and bills.

If the business has more liabilities than assets, the current ratio will be less than one. If the business has more assets than liabilities, the current ratio calculated will be more than one.

If a business’s current ratio is high, it indicates it has a safety cushion. If the business has more assets than liabilities, its flexibility will be increased. If the business has more liabilities than assets, it might have to convert its receivable balances and some inventory items into cash, which may not be quickly done.

Businesses can enhance their financial health by strategically managing various aspects of their operations. This includes prioritizing debt repayment, promptly collecting receivables, purchasing inventory only as needed, and considering converting short-term debts into long-term obligations to bolster their current ratio.

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Liquidity Ratio

Liquidity ratios can be found in three types:

  1. Current ratio: Calculated when the sum of the company’s current assets is divided by their total current liabilities. This ratio measures if you have sufficient assets to pay for your liabilities. If your current ratio is calculated to be two, you have twice as many current assets as your current liabilities.
  2. Quick or acid-test ratio: This ratio is calculated by dividing current assets (not including stock) by the total current liabilities. If your quick or acid-test ratio shows the result of one, it means your business’s liquidity levels are sufficiently high. This is an indication that your company has solid financial health.
  3. Defensive interval: This ratio is calculated by dividing the total liquid assets by daily operating expenses. The ratio will estimate how long you can survive your business without any cash flowing in. Normally, it is found to be somewhere between 30 to 90 days.

Download A Free Financial ToolkitSolvency Ratio

Solvency ratios measure a business’s financial stability by calculating its debt relative to its equity and assets. A business with too much debt might not have enough flexibility to manage its cash flows if interest rates rise or business conditions deteriorate.

The common solvency ratios calculated are debt-to-asset and debt-to-equity. The debt-to-asset ratio is found by dividing total debt by the total assets. The debt-to-equity ratio is calculated by dividing total debt by shareholders’ equity. Shareholders’ equity is found by calculating the difference between all total assets and liabilities.

Profitability Ratio

Profitability ratios calculate the management’s ability to change the amount of sales dollars earned to cash flow and profits. The net profit ratio can be used to evaluate your business’s profitability. Divide the total profit before tax by the net sales amount to determine your net profit.

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