How You Can Use Financial Ratios To Improve Your Business

Financial ratios offer entrepreneurs a way to evaluate their company’s performance and compare it other similar businesses in their Industry. You can find many of the ratios, for your industry, using the North American Industry Classification System (NAICS). Your accountant or your bank and industry associations often have information on ratios. Statistics Canada is an additional source for statistics related to wide variety of industries, although the information may be from several years ago.

Ratios measure the relationship between two or more components of financial statements. They are used most effectively when used in relation to your specific industry. Collecting results over several time periods will allow you to follow your company’s performance and uncover signs of trouble.

Here are some key financial ratios to measure the financial health of your business:

Leverage ratios

1.?Debt-to-equity ratio?= Total liabilities / Shareholders' equity

Measures how much debt a business is carrying as compared to the amount invested by its owners. This indicator is closely watched by bankers as a measure of a business’s capacity to repay its debts.

2.?Debt-to-asset ratio?= Total liabilities / Total assets

Shows the percentage of a company’s assets financed by creditors. A high ratio indicates a substantial dependence on debt and could be a sign of financial weakness.

Liquidity ratios

1.?Working capital ratio?= Current assets / Current liabilities

Indicates whether a business has sufficient cash flow to meet short-term obligations, take advantage of opportunities and attract favourable credit terms. A ratio of 1 or greater is considered acceptable for most businesses.

2.?Cash ratio?= Liquid assets / Current liabilities

Indicates a company's ability to pay immediate creditor demands, using its most liquid assets. It gives a snapshot of a business's ability to repay current obligations as it excludes inventory and prepaid items for which cash cannot be obtained immediately.

Profitability ratios

1.?Net profit margin?= After tax net profit / Net sales

Shows the net income generated by each dollar of sales. It measures the percentage of sales revenue retained by the company after operating expenses, interest and taxes have been paid.

2. Return on shareholder's equity = Net Income/ Shareholder's Equity

Indicates the amount of after-tax profit generated for each dollar of equity. A measure of the rate of return the shareholders received on their investment.

3. Coverage ratio = Profit before interest and taxes / Annual interest and bank charges?

Measures a business's capacity to generate adequate income to repay interest on its debt.

4.?Return on total assets?= Income from operations / Average total assets

Measures the efficiency of assets in generating profit.

Operations ratios

1. Accounts receivable turnover = Net sales / Average accounts receivable

A higher turnover rate generally indicates less money is tied up in accounts receivable because customers are paying quickly.

If you want to determine the financial health of your business monitor these ratios, you may also want to engage a Fractional CFO to help set up and monitor these various ratios so that you can maintain a healthy financial position for your company.??

Belynda De Beurs,?CPA

Owner, RoadMap to Profit

P.S. At Roadmap to Profit we work with business owners, in the construction Industry for over 14 years. We help our clients manage financial reporting so you, as a business owner, have a clear picture of your financial position on a regular basis. Monitoring ratios will give you peace of mind and help increase profit.?RoadMap to Profit offers fractional CFO services at affordable rates.?Book a free 30-minute consultation https://calendly.com/belyndartp/consultation send us an email [email protected] or give us a call (403) 992-7261. We look forward to hearing from you.