Financial ratios: what every small business owner must know

Calculating financial ratios gives small business owners a picture of how their business is performing. To be successful, here's what you must know about them.
Financial ratios are a series of calculations that evaluate profitability, debt ratio, productivity and solvency of a company. Financial ratios are relationships determined by a company's financial information and used for comparison purposes over a period of time.

Financial ratios: what every small business owner must know

Financial ratios yield important results

Although all are relevant, some calculations paint a clearer picture than others of the health of your business:

  • Net profit margin: This figure is derived from the ratio between the net profit of the company and its overall sales. The net profit margin would indicate the profit (after tax) on every dollar received by the company.
  • The debt ratio: This ratio is the relationship between the assets and liabilities of the company. A figure less than 1 would mean that less than half of the company's assets are financed by creditors.
  • The inventory turnover ratio: As the name suggests, this ratio determines the turnover of the goods sold by the company. This calculation is a good indicator of the financial success of a company.

Why are financial ratios useful?

There are two main types of ratios: ratios related to financial stability and ratios related to profitability. The results of these two categories of ratios enable entrepreneurs to make a realistic assessment of the financial health of their company.

  • Financial ratios are often used by entrepreneurs who are expecting an increase in spending or an expansion of their business. This review of your businesses finances can be very useful. For example, it can show you if you are borrowing money more often compared to your business revenue increases.
  • Financial ratios are very useful to help you understand not only the current financial state of your business, but also the financial changes over time. Among their many uses, these ratios can also be used by the public to estimate the profitability of a company.

How do you calculate financial ratios?

There are several ways available to obtain or calculate the financial ratios for your business.

  • There are online tools available to help you determine the financial picture of your company.
  • Your bank is also a great resource. Many have online tools to allow you to calculate the financial ratios for your business. At the bank’s location, you can obtain personalized service to help you in this regard.
  • Financial advisers and accountants can also be a great help when setting up your business and determining how well it is performing.
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