10+ Ways to Monitor Your Company's Financial Performance

Introduction

As a small business owner, one of the most important things you can do to ensure your business’s continued success is to closely watch the finances. Understanding the money coming in and going out of your business (recorded on the Statement of Cash Flows if you have an accountant preparing financial statements) is one way to do this. You might also look at how much you’re selling, how many appointments you’ve booked or what services are most in demand. These are all helpful but none of them give you a clear “bird’s eye view” or trend of how your company is doing financially.

Luckily there are a lot of simple ratios or formulas that you can use to see your company’s basic financial situation. We’ll go over 13 of these in this article, and you’ll see when and why you might pick one or the other. These are broken up into 4 categories:

Debt Ratios

Debt Ratios measure how much debt your company has relative to how much the company is worth. This is similar to your personal net worth, like the Debt-to-Income ratio your bank might calculate if you were applying for a home loan.

Liquidity Ratios

Liquidity Ratios measure your company’s ability to pay unexpected bills by looking at how much liquid money or cash you have. Sometimes a lot of your company’s money is “tied up” in equipment, land, or other things that are harder to sell quickly.

Profitability Ratios

The third type of ratio, Profitability Ratios measure how much money your company makes for each dollar that you spend so you can understand if your company is becoming more or less profitable over time.

Efficiency Ratios

The last type are Efficiency Ratios. These ratios help retailers and others who sell physical products understand how long it takes their products to sell, how long inventory remains on the shelf and how long it takes them to get paid.

Debt Ratios

Now that we’ve got an understanding of what these ratios are, let’s dive in with Debt Ratios.

Basic Debt Ratio

The basic debt ratio formula is: Long Term Debt / Total Assets. Assets are anything that your company owns. This includes accounts receivable (outstanding money that people owe you), cash, the value of your inventory, land, equipment, and so on.

Let’s say you have a $30,000 loan outstanding and you add up the cost of your store: $25,000 in inventory, $2,000 in cash, $10,000 in equipment. Your debt is $30,000 and your assets are $25,000 + $2,000 + $10,000 = 37,000.

So your debt ratio is $30,000 / $37,000 = 0.81. For each dollar of assets you have, you have 81 cents in debt. A debt ratio of greater than one means your company has a negative worth, because if you were to sell all your assets you still wouldn’t be able to pay off the debt.

For this reason, a lower debt ratio is better.

Times Interest Earned Ratio

The Times Interest Earned ratio is measures your company’s ability to make its interest payments on the debt that you have. The official formula is EBIT / Interest (dollars). EBIT stands for earnings before interest and taxes. This is more commonly used with large corporations, but basically what it means is how much money did your company make?

Take your cost of goods sold (abbreviated as COGS), your selling and administrative expenses like gross payroll but not interest that you’re paying on your debts, or the income tax that you pay on your profit and subtract it from your gross profit.

Take a look at the chart below to see how you calculate EBIT. Don’t worry about depreciation, amortization and non-operating right now if you don’t know what those, that’s a topic for another day.

So, now we take the EBIT and we divide it by the interest that you pay in dollars over that same period. Let’s say that the above numbers are for a quarter (3 month period.) You have a new loan that you pay 8% interest on. It’s for 10-year and $50,000.

Your payment is $660.75 and in the first 3 months you pay $1,243.88 in interest. (If you want to see the whole chart, you can find it here: https://edfinancial.com/amortizationschedule?pmts=120&intr=10&prin=50000)

When you divide $4,505 / $1243.88 you get 3.62. A bigger number is better, because it means you can make your interest payments for more time.

Liquidity Ratios

Liquidity ratios help you understand how quickly your company is able to pay short-term loans and other unexpected cash expenses. Liquid assets are those things you can turn to cash very quickly like cash itself or money market investment funds. Illiquid assets are things that can’t easily be turned into cash like land or heavy equipment.

There are two liquidity ratios, the current ratio and the quick ratio – also called the acid test.

Current Ratio

The current ratio is Current Assets / Current Liabilities.

Current assets are the assets you have on hand right now and will have within a short period, usually your sales cycle. So, if you require payment from your customers within 30 days, your Accounts Receivable due within 30 days will be considered a current asset.

At the same time, the debts you owe within that 30 day period will be considered your current liabilities. This might be credit card payments, loan payments, utility bills and other bills you’ll be required to pay within that same sales cycle.

For example, if you have $2,000 in current assets (sales) each month and $800 in current liabilities then your current ratio is 2.5. A bigger number is better because it means you have more assets than liabilities.

Acid Test

The acid test is very similar to the current ratio but you subtract your inventory from your current assets. So if you have $2,000 in current assets but $500 of that is inventory, your current ratio is 1.875 instead.

The reason you subtract inventory is that inventory can be difficult to liquidate or sell quickly.

Profitability Ratios

Profitability ratios measure how much money your company is bringing in above the amount it takes to run the company (the amount of profit you make.) A profitability ratio is especially useful to watch over time, so you can see if your company is getting more or less profitable.

Sometimes you bring in a new product and find your sales increasing, but your expenses increase too – and you might find yourself with less money when you finish.

Net Profit Margin

The net profit margin measures the earnings you have for each dollar of sales. You calculate it by taking your net Income and dividing it by your revenue.

When you take the $7,800 net income and divide it by the sales ($30,000) you get the net profit margin of 0.26. This means that for every $1 in sales, you make 26 cents in net income. You can double-check the math by taking $30,000 and multiplying it by 0.26. The result is $7,800.

Return on Assets

The ROA measures the profitability of your assets. If you have a lot of equipment that you don’t use for example, this will drive your ROA down as you make less money for each dollar of asset that you own. If you own a lot of inventory but it never sells, you’ll have a similar situation.

You calculate ROA by taking your net income and dividing it by your total assets.

So if the total assets in your store are $20,000 and you make $60,000 in sales each year then your ROA is 3.0, meaning for each dollar you have invested into your store you make $3 in sales. A bigger ROA means your store is being more efficient with its assets.

Gross Profit Margin

The GPM measures your product pricing in comparison to its basic cost. How much markup are you applying to the products or services that you sell? This ratio is more common and useful for retail or product-based businesses (e.g. upholstery or restaurants) than it is for knowledge-based businesses like insurance sales.

You calculate your GPM by taking your revenue, subtracting your Cost of Goods Sold (COGS) and dividing that by your revenue.

For example, if your revenue is $50,000 and your COGS is $40,000 (you bought $40,000 worth of inventory and sold it for $50,000) your COGS would be:

$50,000 - $40,000 / $50,000
or $10,000 / $50,000 = 0.2

Your GPM is 0.2.

The GPM you want to aim for will vary by industry. Restaurants have a GPM that averages 0.6 but could be from 0.2 to 0.8. Retail stores have thin margins of 0.25 for grocery stores, liquor stores and others will small margins while furniture or clothing stores may be around 0.45.

Efficiency Ratios

Efficiency ratios measure how quickly you get paid and how quickly your inventory gets sold after you buy it, as a way of measuring your efficiency.

Inventory Turnover

Inventory turnover describes how fast the inventory that you buy, gets sold. First, you take your Cost of Goods Sold (COGS) for a given period and divide it by the average value of your Inventory for that same period. For example, if in a year you sold $20,000 throughout the year (COGS) and your average inventory on hand was $1,250 than that means you sold and replaced your inventory:

$20,000 / $1,250 = 16

This means you “turned over” your inventory 16 times, where a bigger number is better because it means you’re moving your inventory faster.

Days Sales Outstanding

Days Sales Outstanding measures the length of time it takes your company to get paid after you make a sale. This is helpful to track if you have difficulty getting people to pay regularly and you’re about to implement some new policies to fix that, or if you notice an increasing length of time in outstanding sales and you want to more deeply understand that trend.

You calculate Days Sales Outstanding (DSO) using the formula Accounts Receivables (money outstanding) / amount of sales multiplied by the number of days. So if one month you make $2,000 in sales and have $400 not paid for, the formula would look like:

($400 / $2,000) x 30 = 6 days

This means that it takes you about 6 days to get paid. This is a great DSO rate. On the other hand, if you have $2,000 in sales but have $1,500 not paid for, the formula looks like this instead:

($1,500 / $2,000) x 30 = 22.5 days

This means that it’s taking much longer for people to pay you.

Asset Turnover

The last measure we’re going to look at is called Asset Turnover. Asset turnover measure the amount of sales you make for each dollar of assets that you own. You calculate asset turnover by diving your revenues by the average total assets at a certain time.

Let’s say you had $60,000 in sales (your revenue) in a year. And the average total assets throughout the year were $10,000. You would divide $60,000 / $10,000 for an asset turnover of 6.0. A higher number means that you’re selling more, and more quickly.

Chart of Ratios and Formulas

Putting It All Together

Once you’ve collected the different components you need to calculate these ratios, you can begin to determine which ones are most relevant for you. Do you feel like you hold a lot of debt? Then it might be helpful to look at the debt ratio. Are you wanting to increase your inventory turnover or the time it takes you to get paid? The DSO or inventory turnover ratios can be very helpful.

It’s important that you try your best to judge yourself by your own criteria and not other people’s because each business has its own unique circumstances. If you’d like SADC’s assistance in calculating these ratios, don’t hesitate to get in touch.