If you’re running your own business, it’s important to have an understanding of the business’ financial standing. While a bank or financial advisor can evaluate your business for you, the equations they use can easily be done by you so you can check up on the financial state of your business and get a regular overview of your financial standing. Using these four ratios to frequently check the financial state of your business will help you improve in any areas and also stay on top of your financial situation.
Quick Ratio / Acid Test Ratio
(Cash + Marketable Securities + Net Accounts Receivable) ÷ Current Liabilities = Quick Ratio
This ratio allows business owners to evaluate whether or not they have enough money to cover their liabilities, such as loans, taxes, debts, and payroll. The higher your ratio is, the better, because it means that you’ll be able to invest more cash back into your business. If you have a ratio less than 1.0, it’s important to focus on paying off your debts before spending money on the business and putting yourself into more debt.
Cash Flow to Debt Ratio
(Net Income + Depreciation) ÷ Total Debt = Cash Flow to Debt Ratio
If you feel you’re having cash flow problems, this ratio could help you see if debt is harming your cash flow. Small businesses often fail due to too little cash flow, so it’s valuable to stay on top of this issue by regularly checking the ratio.
Net Profit Margin
(Total Revenue – Total Expenses) ÷ Total Revenue = Net Profit Margin
This ratio allows you to clearly see how much of a profit you’ve turned with your business. If you notice your net profit getting smaller, you should tighten your budget and focus on increasing that margin. If you’re scaling your business, this decrease is normal, but if there is some other reason your profit lowers, look into it immediately and see how to correct it.
Gross Profit on Net Sales
(Net Sales – Cost of Goods Sold) ÷ Net Sales = Gross Profit on Net Sales
Using this ratio lets you determine how much of a profit you’re making on your sales and whether services can be marked up or down. If your gross profit isn’t as high as you anticipated, you might be under-pricing your items and you should consider raising them. Regularly checking this ratio allows you to catch any issues because it can take a while to correct not making enough on sales. By constantly checking up on your gross profit on net sales ratio, you can fix issues sooner rather than later.
Check out the original article from Due Payments Blog that offers more information about each ratio.