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So, You’ve Made It – But, How Well Is Your Business Doing?

Guest post by: Joseph Lizio

Article Overview: Ever wonder if your business is doing as good as it can? What about understanding if your business is doing as well as your competition? Or, if your business is squeezing the most profits out of the assets and resources it currently has?

So, You’ve Made It – But, How Well Is Your Business Doing?

How strong is your business? How has it faired this downturn? These questions can easily be answered by using simple financial ratios.

Financial ratios are, in a sense, a quick and easy method of measuring your business as it stands and thus gleaning insight on how to improve or at the very least how to keep it from future collapse.

There are three major financial ratio measures:

Liquidity measures your company's ability to pay its immediate or short-term (under one year) obligations. If a business cannot pay its bills - it is destined to fail in the near term - so, use:

The Current Ratio - This ratio is derived by dividing your current assets by your current liabilities. This ratio shows how well your business is positioned to pay its current bills over the next 12 months. If this ratio is below normal or trending downward it could be an eye opening sign that your business is in financial chaos and, if steps are not taken NOW, could be out of business very quickly. Most businesses should have a current ratio between 1.50 to 1.90 - meaning that the business has 1.5 times in current assets to meet its current liabilities.

The Quick Ratio - Like the current ratio, this measure shows if your business can satisfy its immediate (under 90 day) obligations based on its extremely liquid assets like cash and accounts receivables. Here, divide your cash balance and account receivables by your current liabilities. For most healthy businesses a ratio of 0.90 shows that the business has ample liquid resources to meet its immediate liabilities like payroll, interest payments and supplier invoices.

Safety. Safety measures your company's ability to withstand unfavorable market situations - like the current economic sluggishness or future market declines. The inability to withstand such market situation means your business is essentially standing on thin ice - so, use:

The Debt To Equity Ratio - This ratio measure how much your business is relying on debt financing as opposed to equity or business cash flow to finance on going operations. Here, divide your total liabilities by your equity. A healthy business's ratio should be between 1.50 and 2.00 - a ratio of 2.00 means that the business has twice the amount of debt as it does equity. The lower the ratio the stronger your business is as it is relying more on internally generated funds and not outside obligations like debt.

Profitability. Profitability measures your company's ability to cover its overhead (all the expenses not directly related to providing your product or service). This shows your company's ability to cover marketing, selling and payroll expenses as well as taxes and interest payments - so, use:

The Gross Profit Ratio - The goal of any business is to deploy its assets in such a way that it is earning the most for/from those assets. This ratio demonstrates how well the business is efficiently producing or providing products and services. It shows how well products are priced given the direct or variable costs it takes to create or provide them. The bigger the ratio, the higher the profit potential. Here, divide gross profits by sales.

The Pretax Profit Ratio - This ratio demonstrates how efficiently the business is operating overall - showing that overhead expenses are not disproportionate - meaning that the business does not have more expenses than it needs to properly operate the business in generating profits. Here, divide pretax profits by sales. The higher the number the better - meaning that the business does not have excessive expenses in relations to the revenue it is generating.

As with all measures, even though these ratios measure how your business stands, they should always be viewed over time. To get the best insight, it is better to see how these ratios are trending - are they improving or are they falling. While your business may seem OK right now - was it operating better in the past or is it trending in the wrong direction today.

So, to find out how well your business is doing today - after surviving one of the worst recessions in recent history - turn to these simple financial ratios to gain a better understanding of your business and its future possibilities.

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Article Tags: business, financial ratios, profitability, profits, success



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