Business Basics, Start Up / New to Business, Tax & Accounting

Use these 5 Ratios to Grow Your Business

Understanding your business numbers isn’t always easy.  So here are 5 Financial Ratio’s you can use to gain further insight into the performance of your business.

Gross Profit Margin

This is the average gross profit on each dollar of sales before operating expenses

Gross Profit Margin = Gross Profit / Sales

The result you’re looking to achieve will depend on the industry you’re in, so find some industry benchmarks and see how you compare.  This is also a great way to assess the profitability of each product that you sell.  You can then make decisions regarding future prices, promotions or discounts you might run and also whether you continue to stock that line of product.

Net Profit Margin

This shows you the percentage of profit your business makes for every dollar of revenue.  It tells you if you are making a profit after covering ALL your costs.  Again, it is influenced by your industry.  Some retailers operate on high-volumes of transaction but low margin business; others sell a few expensive items that carry a lot of margin.

Net Profit Margin = Net Income / Sales

Current Ratio

This ratio helps you measure how solvent your business is by comparing assets to liabilities.

Current Ratio = Current Assets / Current Liabilities

A good current ratio should be 2 or more, which means that your assets are at least double your liabilities.  However, if you are growing your sales and have a short operating cycle, a lower number may still be fine.  Be sure to check that all your assets and liabilities are classified correctly before running this number.

Inventory Turnover

Useful if you have trading stock, this ratio shows you how often your inventory is sold and replaced for a particular period.

Inventory Turnover = Cost of goods sold / Inventory

For example, say you’ve spent $200,000 on stock over the year and you keep an average of $20,000 worth of stock on hand, your inventory turnover is 10 times per year.  It’s better to have a higher inventory turnover rate than lower as this means that you don’t hold too much stock, just be careful that your result isn’t too high as this could indicate that you don’t hold enough stock to meet your sales orders.

Return on Owner’s Equity

This ratio shows you how much you’re making from your investment in your business.

ROE = Net Income / Owner’s Equity

If you’ve invested $200,000 into the business and the business generates a net income of $100,000 a year, your return on equity is 50%.  The return tends to increase over time as the business grows, especially if you don’t continue to contribute equity into the business.  This ratio is a useful way to compare what you’re earning from your business to other investment options.

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