Keeping an eye on your business financial health is easier than you think. There are three simple financial ratios we at BLD Consulting use to assist our client to keep track of their business financial health. The financial ratios allow our clients to see how their business is operating and compare to other businesses within the industry.
The Financial ratios analysis will provide a simple and effective method to tell you the health of your business. By calculating these three financial ratios you will find out how your business current performance in the current market place, diagnose any potential problems the business is facing and to compare past financial ratios with the current one to see if the business is improving or the business need additional help.
The quick ratio is an excellent diagnostic tool similar to the current ratio except that it excludes inventory. Giving you a more cautious figure. In general, the higher the ratio, the better it is. It measures whether or not your business has enough resources to pay its bills over the next 12 months.
The formula is:
Quick ratio = Current assets – Inventory /Current liabilities
To calculate the Quick ratio, you need to find the current assets on the balance sheet, Remember, current assets are assets that can be converted back into cash within one year.
Current liabilities are on the liabilities side of the balance sheet that represent financial obligations that are expected to be settled within 12 months.
To put it in context, a company has $800,000 in current assets excluded Inventories and 600,000 in current liabilities, then the quick ratio is $800,000/$600,000 =1.33:1
For every dollar in current liabilities, there is $1.33 in current asset excluded Inventory. That is a fantastic news, but make sure you compare the quick ratios with the last 3 years to see how your company is performance.
The total Debt Ratio shows how much debt your company has and it is an excellent ratio to check your business’s long -term solvency. The formula is:
Total debt ratio = Total debt/Total assets
From your Balance sheet you can find the total debt and total asset and the you can find these numbers from your balance sheet.
For example, a business with $220,400 in total assets and $250,000 in total debt would have a total debt ratio of $250,000/$220,400 = 1.11:1.
Our business example has $1.11 dollars in debt for every dollar of assets. Therefore, this business, the total debt ratio tells us that this business is not doing well and will need some serious help to get the company back to go health.
3) Profit margin
Profit margin shows how much net profit your business based on your sales. To calculate profit margin the formula is:
Profit margin = Net income/Revenue
For instance, if a business’s revenue is $1,800, 980 while its net income is $628,925, its profit margin is $628,925/$1,800,980 = 35%. For Every dollar in revenue, this business is generating 35 cents net profit.
Again, higher the profit margin the better for the business but remember to compare the profit margin over a period of 4 to 5 years to measure the overall performance.
These three Financial ratios will help you to measure the health of your business and it is the easiest to use tool to keep an eye on your business and keep track of how it is performance.
About the Author: Nathaniel Lee
Nathaniel is the CEO for BLD Consulting and leads seven experienced consultants to provide services to clients and offer solutions to their needs. As a facilitator and course content writer for Financial Management, Postgraduate unit at Swinburne Technology of Swinburne, Nathaniel has been successfully teaching professionals how to measure the health of their businesses/companies and ultilise the financial information to make the right decisions. Now, a personalised workshop with individual business is available at your preferred location. Contact us today via firstname.lastname@example.org or (03) 9018 7388 for a quotation