Financial Ratios You Need for Your Small Business Part I


Financial ratios are a powerful tool to help you assess your small business finances. They can measure your operational efficiency compared to competition, profitability, financial stability, and more. Today, we share this cheat sheet of must-have financial ratios to keep in your pocket!

Financial Ratios on the Balance Sheet

Working Capital

Working Capital = Current Assets - Current Liabilities

When You Use It:

Use the Working Capital ratio when you want to find if the company can meet its current obligations (bills, payroll, loan payments, etc). Your current assets should be larger than current liabilities to ensure you have working capital leftover.

Current Ratio

Current Ratio = Current Assets / Current Liabilities

When You Use It:

Use the Current Ratio when you want to find the relationship between your current assets and current liabilities. You want the current assets to be greater than your current liabilities to ensure you have working capital. For example, a 3:1 ratio means you have working capital left over, a 1:2 ratio means you have more current liabilities than current assets, and a 1:1 ratio means you have just enough to manage your current liabilities but no working capital leftover.

Quick Ratio (AKA Acid Test Ratio)

Quick Ratio = [(Cash + Temporary Investments + Accounts Receivable) / Current Liabilities] : 1

When You Use It:

The Quick Ratio excludes inventory, supplies, and prepaid expenses so you can quickly see the relationship between easily liquidable assets versus current liabilities.

Financial Ratios on the Income Statement

Accounts Receivable Turnover

Acct. Rec. Turnover = Net Credit Sales for the Year / Average Accounts Receivable for the Year

When You Use It:

Use the Accounts Receivable Turnover ratio when you want to see how many times per year your accounts receivable turnover. Remember this is just an average, but it can help you adjust accordingly as you fluctuate throughout the year.

Days' Sales in Accounts Receivable

Days' Sales in Acct. Rec. = 365 / Acct. Receivable Turnover in year

When You Use it:

Use the Days' Sales in Accounts Receivable Ratio to find the average number of days it takes to collect the average number of receivables. Be sure to carefully compute your Accounts Receivable Turnover Ratio to get the correct computation!

Inventory Turnover

Inventory Turnover = Cost of Goods Sold for year / Average Inventory for Year

When You Use it:

The Inventory Turnover Ratio is the number of times per year your inventory turns over on average. Be sure to use Cost of Goods Sold, not sales value, when calculating this ratio!

Days' Sales in Inventory

Days' Sales in Inventory = 365 / Inventory Turnover

When You Use it:

Use the Days' Sales in Inventory Ratio to find the average number of days it takes to sell your inventory in a year. Be sure to carefully compute your Inventory Turnover Ratio to get the correct computation!

We'll be back next week with Part II!

Sources:

www.PracticalAccountingVA.com

www.accountingcoach.com

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Disclaimer: The views presented in this post are meant as educational resources and should not be taken as direct advice for your personal finances or small business. Should you have questions regarding a post relating to your specific finances, please contact us at info@practicalaccountingva.com.

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