Financial data is difficult to analyze and use if you don’t put them into context and know what to look for. Numbers in your accounting books are important, but you need to understand how to measure them effectively. This is when knowing the best financial ratios for small business owners becomes vital.
What are the most important financial ratios?
Net Profit Margin
You get this financial ratio after deducting all expenses, taxes and interest from the revenue. Business owners monitor this because it reveals the profitability of a company. It shows how effective an owner is at generating profit while managing expenses. For example, a profit margin of 5% means that you make 5 cents for every dollar you sell to customers.
A low or declining profit margin is a sign of poor performance. Sales might be decreasing because of factors such as bad customer service, employee theft, inefficient processes and others.
You get the quick ratio by dividing the total of cash, net accounts receivable and marketable securities with your current liabilities. This measures your company’s ability to pay current liabilities and its chances of survival in times of financial downturns. If you have plans to expand your small business, your quick ratio should be higher than 1.0. If your quick ratio is lower than 1.0, it is ideal to pay debts first and accumulate enough cash for investments.
Cash Flow to Debt
Why do some small businesses have cash flow problems despite making money? One of the reasons this is so is because their cash goes to paying debts. The cash flow to debt ratio provides you with signs that your business might be in trouble with debt repayments. You get this by dividing the total of the net income and depreciation with your total debt. Make sure you are liquid enough to pay debts once they are due.
Sales per Employee
One of the ways to determine how expensive it is to maintain business operations is to review your sales per employee ratio. To get this, divide your annual revenue with your number of employees. A high ratio means that your employees are delivering efficiently. As your small company expands, you’ll likely add employees. If the ratio stays at the same level or increases, there’s no drop in efficiency.
These are some of the best financial ratios for small business owners to monitor and record. These ratios determine the profitability and efficient use of resources of your company. If you need affordable bookkeeping services, send us an email at [email protected]