4 critical financial ratios small business owners should track
Small businesses need to be careful about their financial actions, especially during the early years, and should take a look at their critical financial numbers regularly to keep track of their performance. Numbers that you need to track closely can be found easily on different reports like the Cash Flow Statement (Statement of Financial Performance) & Balance Sheet (Statement of Financial Position). But before you look into these, you should know what ratios you should be tracking closely. Here are the top 4.
Here are 4 financial ratios you should know & be tracking closely.
1. Gross margin
Also known as gross profit, gross margin represents the value after deducting direct costs from your income. It is the amount that you’re left with for covering your overhead costs or indirect costs. Direct costs are the costs that you have to bear in selling your services and products. They include the cost of manufacturing or purchase, freight, duties, customs, interest paid, losses, local delivery, etc. Deduct all the direct costs from your income and keep an eye on your gross margin.
Every single business out there tracks its sales. Sales-to-revenues ratio is probably one of most significant figures that you need to keep an eye on. However, a mistake made by most of the executives is that they do a comparison of most recent numbers with those of past. It may be more beneficial if you do a comparison of current numbers with what you want to achieve in the future.
3. Quick ratio
For calculating this ratio, you have to add accounts receivables and cash at hand, then use the result and divide by your current liabilities or accounts payables. This number is considered really important for staying on top as it lets you know exactly how much you have in cash for dealing with all the bills. At bare minimum, you should have one-to-one ratio as it means there is sufficient cash available for paying all the bills and meeting all your obligations. For some breathing room, a two-to-one ratio is what you should be targeting. However, if there is some really big number that is stuck in the receivables, it may mean that there is not enough cash available.
If your business is indebted, you can find this ratio on a quick check of the balance sheet. This ratio is useful for determining whether the existing debt allows for your financial goals to be met, as well as determining the budget available for paring down the level of debt.
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