Are you a business owner? Do you know how well your business performed in relation to your industry? If not, you should consider doing a financial ratio analysis.
It's not as complicated as it sounds, especially when using our financial ratio calculator. Financial ratios are a helpful way to see how you are doing and to compare your business to other businesses.
Below is our FAQ on everything you need to know about financial ratios.
If you've ever tried to get a bank loan for your business, your banker used financial ratios to assess your financial position.
So why does that matter to you? Because if you can calculate your own ratios, you'll know your odds of getting approved. You'll also have a better grasp on your financial situation and if you truly can afford to take on another loan.
This only just scratches the surface on financial ratios. You can use financial ratios to figure out what other areas you need to improve on and where you can make more money.
A financial ratio calculator is a great tool that you can use to figure out where you need improvement and what you do well. It helps you compute 12 of the most common financial ratios.
Our financial ratio calculator can be incredibly helpful for analyzing your financial situation. Using this tool saves valuable time and guarantees accuracy in your calculations.
It's important for business owners to know where their business stands relative to the competition. A good financial ratio analysis done at least once per year can give you a clear picture of where your company stands.
Better financial knowledge means more money in your bank account.
The four most common types of ratios are liquidity, asset management, profitability, and leverage. Let's take a closer look at each.
Liquidity is used to determine if you have enough cash to cover your immediate debts. What is an immediate debt? Anything that's due within the next 12 months.
This number changes almost daily for some businesses.
It includes interest due on an operating line of credit. Bills payable like insurance, utilities, and supplier bills. Current debts also include payroll and taxes due.
To pay these current debts, you'll need assets that are easily converted to cash. AKA, current assets. Current assets include cash, accounts receivable, and inventory on hand.
Common liquidity ratios include:
This category of financial ratios determines how efficient your business is at turning its assets into sales. The most common ratios in this category are:
Both of these ratios calculate time, such as the time it takes your company to convert inventory into sales. Or how long it takes your company to collect receivables.
The longer your company holds onto inventory, the less money you'll make in the long run. Same with receivables.
Of course, both of these ratios are only useful as they relate to the industry. In general, you want to see both of these numbers under 30 days.
Certain industries have longer billing cycles. An example would be road construction. Road construction is almost always funded by the local, state, or federal government.
These agencies tend to take longer to pay. Therefore, a 60-day receivables turnover might be okay.
These ratios show how well your business generates income relative to its expenses. The most common include:
Profit margin determines how much bottom line income you produce after you've deducted expenses.
Return on assets (ROA) shows how well your company is at using assets to create income. A higher ROA in relation to your industry means you make more money using fewer assets.
Return on equity (ROE) is like ROA but it uses equity instead of assets.
Leverage ratios tell you how leveraged your company is. By leveraged, we mean how much debt you have relative to the value of your company. A large, highly leveraged company is worth less than a smaller company with very little debt.
The most common leverage ratio is:
It's calculated exactly as it sounds: total debt divided by net worth.
Again, your D/W depends on your industry. Some industries, like finance, need more leverage than others. But in general, you want your D/W to be below 1:1. Meaning, your debt is less than or equal to your net worth.
An important ratio for determining cash flow is the debt service coverage ratio (DSCR). It tells you how well your business can repay debt obligations.
Defining the most important ratio depends on your circumstance.
Are you applying for a loan? Are you trying to improve profitability? Is your business growing?
Your answers to these questions determine which ratios you need to pay more attention to.
ROA is a great measure of how much you make relative to what you invest in your company. But it only shows you the big picture.
To see you where you're losing money and how you can be more profitable, you may want to do a profit margin analysis.
There are three types of profit margin: gross, operating, and net.
Our financial ratios calculator includes all three types of profit margins in your analysis.
Most financial ratios are easy to calculate and require you to divide one figure into another. Due to the many types of financial ratios, this can quickly become time-consuming.
The best way to go about this is to use a financial ratios calculator. You'll know better which facts and figures to use, and you get your ratios instantly while avoiding pesky equations. The best online tools will analyze a number of ratios at a time.
We'll go over an important ratio for profitability, ROA.
Let's say that your business shows initial assets of $12,000 and final assets of $15,000. During the current year, your business had a net income of $100,000.
ROA = $100,000 / (($12,000 + $15,000)/2)
ROA = $100,000 / $13,500
ROA = 7.41%
That means for every one dollar you spent on assets during the year, you generated $7.41 of net income. Whether this is good or not depends on the economy and how other similar businesses are performing.
For more great tools to streamline your operations, see our full list of business calculators.