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There are quite a few ways you can note and record your business performance using available data. Using financial ratios, you are easily able to assess all of the areas where your business performance is excelling or underachieving. This way, you are able to judge where you need to improve in the areas you lack and where you need to retain and maintain the areas you have had success.

The other motive of using financial ratios in your business is that you are able to see and decide just how beneficial or disadvantageous it will be in one area if any such modifications are made. You can easily measure the effects that the changes will have elsewhere in another area.

The importance of monitoring figures closely in your business will help you to minimize waste and maximize efficiency which will, in return, grow and flourish your business in time.

Where do you get your information to calculate your financial ratios? Bookkeeping will help you in providing all of the necessary and relevant information from which all of your accounts are formulated. The process of bookkeeping is a recognized and well-defined process in the field of business and accounting.

Each and every transaction, whatever the nature (purchase or sale) may be, has to be recorded. The process of bookkeeping helps ensure accurate and timely records.

4 Ways to Assess Your Business Performance Using Financial Ratios

 

  1. Current Ratio

The most regular and familiar ratio used is called the current ratio. This ratio calculates the ratio of current assets to the ratio of current liabilities. The current ratio is used to help specify a company’s potential and capacity to pay off their short-term invoices and bills.

If the business has more liabilities compared to their assets, the current ratio will be less than one. If the business has more assets compared to their liabilities, the current ratio calculated will be more than one.

If a business’s current ratio is high, it indicates they have a safety cushion. If the business has more assets than liabilities, their flexibility will be increased. If the business has more liabilities compared to their assets, they might have to convert their receivable balances and some inventory items into cash, which may not be easily done.

In order to improve their current ratio, business can pay off their debts, collect their due receivables, purchase inventory only when required, and convert their short-term debts into long-term debts.

  1. Liquidity Ratio

Liquidity ratios can be found of three types:

1. Current ratio: Calculated when the sum of all of the company’s current assets are divided by their total current liabilities. This ratio measures if you have sufficient assets to pay for your liabilities. If your current ratio is calculated to be two, it means that you have twice as much current assets as your current liabilities.

2. Quick or acid-test ratio: This ratio is calculated by dividing current assets (not including stock) by the total current liabilities. If your quick or acid-test ratio shows the result of one, it means your business’s liquidity levels are sufficiently high. This is an indication of your business having solid financial health.

3. Defensive interval: This ratio is calculated by dividing the total liquid assets by daily operating expenses. The ratio will give an estimated idea of how long you can survive your business without any cash flowing in. Normally, it is found to be somewhere between 30 to 90 days.

  1. Solvency Ratio

Solvency ratios measure the financial stability of a business since it calculates a business’s debt in respect to its equity and assets. Any business found to have too much in debt might not have enough flexibility to manage their cash flows if the interest rates are found to rise or if the business conditions start to deteriorate.

The common solvency ratios calculated are debt-to-asset and debt-to-equity. The debt-to-asset ratio is found by dividing total debt by the total assets. The debt-to-equity ratio is calculated by dividing total debt by total shareholders’ equity. Shareholders’ equity is found by calculating the difference of all total assets and all total liabilities.

  1. Profitability Ratio

Profitability ratios calculate the management’s ability to change the amount of sales dollars earned to cash flow and profits. The net profit ratio can be used to evaluate your business’s profitability. Divide the total profit before tax by the amount of net sales to find out your net profit.

Check out America's Best Bookkeepers
About Complete Controller® – America’s Bookkeeping Experts Complete Controller is the Nation’s Leader in virtual accounting, providing services to businesses and households alike. Utilizing Complete Controller’s technology, clients gain access to a cloud-hosted desktop where their entire team and tax accountant may access the QuickBooks file and critical financial documents in an efficient and secure environment. Complete Controller’s team of  US based accounting professionals are certified QuickBooksTMProAdvisor’s providing bookkeeping and controller services including training, full or partial-service bookkeeping, cash-flow management, budgeting and forecasting, vendor and receivables management, process and controls advisement, and customized reporting. Offering flat rate pricing, Complete Controller is the most cost effective expert accounting solution for business, family office, trusts, and households of any size or complexity.

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A brand new business owner may not necessarily be found as a financial expert. It is quite common and natural that a start-up will often be required to take a loan. Investors normally wish to be provided with an extensive financial analysis and data before they consider granting any such loan to the owner for their start-up.

So, what is this data and where does it come from? The data is from the bookkeeping records that calculates all of the company’s financial ratios. These ratios define the health and well being of a business along with the risks. Investors are highly interested to see these facts and figures before deciding if they wish to invest in that certain business or not.

Ratio analysis is one of the most recognized methods used for determination of a business’s overall financial condition. These ratios are also found to be most useful in making comparisons and assessments between a client and other companies found in the industry.

In the field of accounting and bookkeeping, each and every one of the below ratios are extremely important for credit professionals to make informed decisions. They are able to judge and decide if they should or shouldn’t give credit to customers, exactly how credit worthy the business is, how much they should invest, and what the appropriate terms of sale should be.

Financial Ratios That Lenders Review when Deciding the Credit Worthiness of a Business

 

  1. Debt-to-Equity Ratio

The debt-to-equity ratio permits lenders to compare a company’s assets with its debts. A lender considers a business as a high risk when their debt to equity is a high ratio. They would much rather invest in a business where the ratio calculated is found to be of little or no debt.

In order to calculate the debt-to-equity ratio, take a company’s recent balance sheet. Divide the figure of total liabilities by their total figure of shareholder’s equity. Take an example, a business with a figure of $200,000 as liabilities and a figure of $400,000 as assets. That company’s debt-to-equity ratio will be calculated as 0.5.

 

  1. Operating Margin

An operating margin is used to calculate a company’s profit as a percentage of their total sales. Operating margins find a company’s total revenue and total profit. These figures give a clear picture of where the company is standing in terms of efficiency.

In order to find out the operating margin of a company, divide the income from operations by the total figure of net revenues. Take an example, a company with a figure of $1 million from $100 million yearly profits from their sales, will have their operating margin calculated at 1%.

  1. Current Ratio

Current ratio is used as a liquidity ratio. This ratio is calculated when the total sum of all current assets is divided by the total current liabilities. This ratio measures if you have sufficient assets to pay for your liabilities. If your current ratio is calculated to be two, it means that you have twice as much current assets as your current liabilities.

This ratio is similar to the ratio of debt-to-equity, though in this case, total assets are divided by total liabilities instead of liabilities divided by shareholder’s equity.

  1. Inventory Ratio

A company’s production and purchasing efficiency can be calculated by using the inventory ratio. The inventory ratio gives a fair picture of how many times the company is able to sell their inventory for a specific period of time.

In order to calculate this ratio, divide the entire cost of the services or products sold with the entire inventory cost. If the ratio is higher, it means the company is more efficient at turning over their inventory. Lenders will take and consider such businesses as credit worthy and most likely to be successful and productive for investment.

Let’s take an example for this. If a business has sales of $500,000 and inventory of $100,000, the inventory ratio calculated will be 5-to-1.

Check out America's Best Bookkeepers
About Complete Controller® – America’s Bookkeeping Experts Complete Controller is the Nation’s Leader in virtual accounting, providing services to businesses and households alike. Utilizing Complete Controller’s technology, clients gain access to a cloud-hosted desktop where their entire team and tax accountant may access the QuickBooks file and critical financial documents in an efficient and secure environment. Complete Controller’s team of  US based accounting professionals are certified QuickBooksTMProAdvisor’s providing bookkeeping and controller services including training, full or partial-service bookkeeping, cash-flow management, budgeting and forecasting, vendor and receivables management, process and controls advisement, and customized reporting. Offering flat rate pricing, Complete Controller is the most cost effective expert accounting solution for business, family office, trusts, and households of any size or complexity.