Financial ratios provide you with ways to analyze data. This allows you to contextualize the position of your small business. It also enables you to determine the profitability of your products and services. Using financial ratios enables you to make prudent business decisions.

 

Here are the different types of financial ratios you should know.

 

Performance

The ratios included in this category reveal a company’s profitability. This is a primary ratio that many owners should be aware of and would want to improve. This includes gross profit margin, net profit margin, return on assets, operating profit margin and return on equity. This type of ratio may also indicate if it is time to raise the prices of your products or services. Profitability is an important parameter that shows you if continuing operations is feasible.

 

Liquidity

This ratio shows a business’ financial capacity to pay debts. A company should have assets and enough cash flow to pay for its short or long-term obligations. Poor liquidity is a sign of financial problems that may lead to business failure or eventual closure. Ratios in this category include current ratio, operating cash flow margin, cash ratio and quick ratio.

You get the current ratio by dividing current assets with current liabilities. This ratio gives you a glimpse of how your small business can pay its debts within the next several months.

 

Activity

If you want to assess the efficiency of your small business’ operations, look no further than your activity ratios. Ratios included here are inventory turnover, payables turnover, total asset turnover, receivables turnover, and fixed asset turnover.

The receivables turnover ratio shows how fast your company’s net sales are converted into cash. For another example, the inventory turnover ratio provides you with an idea about the efficiency of your company’s management of inventory in relation to sales.

 

Leverage

Leverage ratios illustrate the capacity of a business to pay long-term debts. These ratios assess reliance on debt for operations and the possibility to pay dues. Debt ratios, debt-to-equity ratios, and interest-coverage ratios are part of this category.

 

These are key financial ratios for small business owners. They should know these different types of ratios to enable them to make strategic decisions. If you need affordable bookkeeping services, we can help you. We at Robookkeeper can connect you with experienced and skilled freelance bookkeepers.