Six Financial Ratios Every Business Owner Should Use
How many times have you heard somebody say ‘cash flow is king’? I don’t know who coined the phrase but I hope they got a patent on it because it’s so commonly used by everybody else that they never have to worry about cash flow again.
But chances are, in your small business cash flow, revenue, profit and every other financial element of what you’re doing does cause you to worry.
Truthfully, worrying about your small business financial security needs your attention.
According to US Bank’s Jessie Hagen, the top reasons given for a failed business were cash flow problems at 82%, 42% cited an insufficient need for their product or service, followed by a lack of cash and dysfunctional or unmotivated team.
Putting in place sound financial measures when you first start your small business is an afterthought and as business grows, it never really gets corrected.
Logically owners see money going into their business account and just assume what they do is profitable and on the way to achieving what they want to.
But it’s not that simple.
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Who taught you finance?
Short of studying economics at university or having a parent that was a banker, where did you get your financial literacy?
I’m mortified to hear small business owners tell me all the time that when a financial issue comes up they simply Google the answer.
But in a way it makes sense and is understandable. You learnt algebra at school (and haven’t used it since), but who taught you about:
- Tax compliance?
- Salary, overtime, holiday and sick pay?
- Profit and loss?
All of these things and many more directly impact your finances and if you get them wrong and you won’t be in business long.
To me, this lack of teaching students the importance of knowing and understanding how to use your finances (whether in business or your personal life) to build wealth and support you is a major failing in our education system and proves Gary Vee’s point that school equips students to be workers not entrepreneurs.
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How to Practise Smart Financial Management
You’re a small business owner so I can guarantee you of something, you’re a hard worker and don’t back away from the challenge of being a successful one.
However you can be as hard working and courageous as you like, but if your finances don’t shape up the battle will be too great.
There are six financial ratios that every small business owner needs to implement to win that battle.
1. Common size ratio
The common size ratio helps you compare one aspect of your accounting to the big picture of your finances. You calculate each line item as a percentage of the total amount on the statement.
2. Current ratio
A current ratio shows your present financial strength. It represents how many times bigger your current assets are compared to your current liabilities. This is also called a working capital ratio.
3. Quick ratio
A quick ratio shows if you can meet financial obligations, even if something unexpected happens.
4. Inventory turnover ratio
An inventory turnover ratio reveals how frequently you convert inventory into sales. It shows how much product is sold and how efficiently you manage inventory.
5. Debt-to-worth ratio
The debt-to-worth ratio shows how dependent you are on borrowed finances compared to your own funding. It compares how much you owe to how much you own.
6. ROI (return on investment)
ROI compares the amount of money an investment brings into your business to how much you paid for the investment. This ratio shows the money you invest and the profit you get back from it.
Download our E-Book
The 6 Financial Ratios Every Small Business Owner Should Use to learn how to use ratios to compare financial numbers and help your business recognise successes and solve problems.