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7 Financial Ratios Every Small Business Owner Should Know

7 Financial Ratios Every Small Business Owner Should Know

Money is one of the most valuable things in the era of trade and commerce and keeping track of flow is even more crucial. Every commodity or product has a price tag that the owner reviews and adds, which may be sold at the said price or negotiated. Apart from the product prices, other financial matters also require your regular attention. 

For an ongoing business, the financial report contains every little detail of income and expenditure duly noted in a chronology. The financial statement can be overwhelming for start-up farms or any business person taking on accounting for the first time. This is where you will need financial ratios that can quickly help you derive the financial statement and take the best measures possible for the business. 

Financial ratios are essential tools businesses use to turn financial numbers into information. As a type of KPIs (Key Performance Indicator), financial ratios only consider the information on financial statements. A business has different data to look after, and financial ratios can help. They are not just about tracking cash flow but also other aspects such as profit and efficiency. 

In short, financial ratios help in measuring the business health and taking insight to implement solutions or improvements whenever required. However, different financial ratios can confuse any beginner. So here are seven financial ratios that are essentially crafted for small businesses. 

1. Net Profit Margin

Net Profit Margin
Net Profit Margin

Net profit margin falls under the profitability ratios. The net profit margin determines the company’s income from the amount earned through sales. The formula brings out the actual profit after deducting the business expenses. 

Net Profit Margin = Net Income / Net Sales

2. Current Ratio

Current Ratio
Current Ratio

A business needs capital or a certain working capital for paying off debts and loans. This working capital ratio is also known as the current ratio. The current ratio of a company decides if the company is financially strong enough to pay off whatever is owed to them. 

Current Ratio = Current Assets / Current Liabilities

3. Return On Assets (ROA)

Return On Assets (ROA)
Return On Assets (ROA)

The business may have started with capital, but the aim has always been to top the capital amount. The return on assets ratio compares the profit earned by the company with the assets they have previously invested in. The ROA ratio proves the efficiency of the business in financial matters. You can take note of the ROAs of other companies and notice the changes. Bad investments can gradually lower the ROA ratio. 

Return On Assets = Net Income / Average Total Assets

4. Sales Per Employee

Sales Per Employee
Sales Per Employee

For a service-based company with a good number of employees working in the team, measuring the value of sales per employee is helpful. A high sales per employee rate implies that the business is doing well. In addition, as your employee base expands over time, this metric is quite helpful in keeping track of the business growth. 

Sales Per Employee = Annual Revenue / Number Of Employees

5. Gross Margin Ratio

Gross Margin Ratio
Gross Margin Ratio

For a product-based company, the gross margin ratio is considered to be crucial. The company needs to spend a certain amount on operations, employees’ salaries, and many other things combined to manufacture the products. This amount has to be additionally considered after you have already paid for the product manufacturing. 

Gross Margin Ratio = (Sales – Cost Of Sold Goods) / Total Sales

6. Inventory Turnover Ratio

Inventory Turnover Ratio
Inventory Turnover Ratio

The inventory of a business store contains every item the business is producing day in and day out. In addition, the inventory contains raw materials to complete products, whatever has to been sold yet. So, the inventory turnover ratio tells about the efficiency with which the company can manage its inventory. 

Inventory Turnover Ratio = Cost Of Goods Sold / Average Inventory.

7. Debt To Total Assets

Debt To Total Assets
Debt To Total Assets

If you want to figure out the exact number of company assets financed by the investors, the debt to total asset ratio can solve it. Therefore, keeping track of the debt to total asset ratio is vital. Moreover, it can warn about the cautionary tale where the company’s debt may go higher than its total assets. 

Debt To Total Assets = Total Debt / Total Assets

Conclusion

Financial ratios
Financial ratios

Financial ratios are crucial for businesses to figure out different financial matters quickly. It helps the company manage its finances in order. Financial management is for measuring the company’s growth, and financial ratios help in achieving that in almost no time.

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