Running a successful venture requires more than just a great product or service. As a small business owner, you must have a solid grasp of your company’s financial health to make informed decisions and achieve long-term success. However, doing so can be challenging if you’re unsure what to look into.
Fortunately, financial ratios help you assess your business’s financial performance and make data-driven adjustments to optimize your operations. Read below to know more about them.
10 Financial Ratios for Small Business Owners
This financial ratio for small businesses is crucial for assessing your organization’s ability to meet short-term financial obligations promptly. It provides insights into how quickly your company can access money, letting you weather economic storms and seize opportunities without a cash crunch.
1. Current ratio
This type of financial ratio measures your business’s ability to pay off short-term liabilities or those due within one year with its current assets. It’s an important indicator that lets you know your company’s short-term liquidity position and ability to meet immediate financial obligations.
2. Quick ratio
Also known as the acid-test ratio, this type is a more stringent measure of liquidity. Generally, you’ll only include the quick assets— cash, marketable securities, and accounts receivable (AR) —to compute this ratio. You must exclude inventory from your current assets since you might have difficulty converting the former into cash during emergencies.
3. Days of working capital ratio
Sufficient working capital is essential for any business, big or small. With such capital, your company can cover day-to-day expenses and ensure smooth operations. As such, knowing how to calculate your days of working capital ratio is paramount.
This financial ratio determines the number of days your business takes to convert working capital into revenue or sales. Then, you can better understand how efficiently your organization manages its working capital.
Profitability ratios measure your company’s ability to turn a profit. Monitoring these financial ratios for small businesses is vital in identifying if your business is on the right track to achieve sustainable growth and maintain a healthy bottom line.
4. Return on equity ratio
The return on equity (ROE) ratio measures your business’s ability to profit from shareholders’ investments. You can think of this as similar to the return on investment metric—the higher it is, the better the outcome.
This financial ratio can be especially valuable when you want to expand your business and raise funds by pitching your company to get more investors.
5. Return on assets ratio
Calculating the return on assets (ROA) ratio can give you insights into your company’s profitability in terms of its total assets. This type of financial ratio assesses your business’s ability to utilize its assets efficiently to generate profits, measuring the earnings per money spent on total assets.
This category of financial ratios for small businesses focuses on how well your company leverages its resources to generate revenue while managing costs. It evaluates the effectiveness of your business’s asset management, inventory control, and accounts receivable and payable turnover.
6. Inventory turnover ratio
Inventory is essential in business operations. As such, you must know the efficiency of your inventory management and the speed at which your business converts it into sales—which is what this type of financial ratio measures.
The inventory turnover ratio measures how often your business sells and replaces its inventory within a specific period. You refer to this ratio when improving your inventory management and avoiding over- or understocking your items.
7. Average collection period ratio
This ratio evaluates the average days your business takes to collect customer payments, indicating how well your company manages its accounts receivables. It’s an essential metric considering how your accounts receivable can affect your business’s liquidity.
A higher ratio indicates a slower collection of payments. Possible reasons for this include lenient payment policies, poor communication with customers, or inability to pay for products or services. To bring this ratio down, consider setting stricter payment policies and deadlines.
Leverage ratios are essential to understanding your business’s debt levels and reliance on borrowed funds compared to owner’s equity. With this, you can gauge the associated risks of your capital structure and the potential impact on financial stability.
8. Debt to equity ratio
This type of financial ratio for small businesses can help you assess your company’s financial leverage and risk exposure. It measures the proportion of your business’s total debt to its equity capital.
Typically, a low debt-to-equity ratio indicates less risk for lenders and investors. However, a higher number can mean more risk as it suggests that your company uses debt to finance its growth. In that regard, understanding this metric—alongside profitability ratios—can help you persuade investors to fund the development of your new business ideas.
9. Debt to total asset ratio
The debt-to-total asset ratio offers insights into the financial risk associated with your company’s capital structure. It determines how much of your business’s total assets are financed through debt. Results greater than 1.0 or 100% may indicate that your company has more debt than assets.
However, whether a higher ratio is good may depend on your industry’s standards.
10. Debt service coverage ratio
This particular financial ratio assesses your business’s ability to meet its debt obligations comfortably. A ratio of 2 can indicate that your company can generate enough cash flow to cover twice its debt obligations. Typically, this type of financial ratio can be valuable when you need to take out a business loan.
Empowering Your Business with Financial Insights
Alongside developing excellent products and services, keeping your business’s financial health in good shape can help build a solid foundation for success. You can do so by having a keen understanding of your financial ratios. These numbers enable you to make data-driven decisions for optimizing resources and charting a path toward sustainable growth.
If you’re looking to fund your business ventures, reach out to Asialink Finance. We are a reliable financing company that offers low-interest loans to help your company achieve its goals. Check out our blog for more finance tips and guides.