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Check the financial health of your business

Predict the success, potential failure and progress of your business

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  • Easy to use financial ratios to assess the health of your business
  • Work out if you have the funds to pay your bills when they're due
  • Determine whether your business is profitable
  • Calculate if you're getting high enough returns from your business

There are many financial ratios you can use to assess the health of the business – but the ratios we've provided here are the main ones, and are easy for you to use.

The ratios are grouped together under the key areas you should focus on.

Liquidity Ratios

Liquidity ratios assess your business' ability to pay its bills as they fall due – indicating the ease of turning assets into cash. 

In most cases, it's better to have higher ratios in this category (more current assets) than current liabilities as an indication of sound business activities and an ability to withstand tight cash flow periods.  

Current ratio

Current ratio = Total current assets
                       Total current liabilities

As one of the most common measures of financial strength, this ratio measures whether the business has enough current assets to meet its due debts with a margin of safety. 

A generally acceptable current ratio is 2:1, but this depends on the nature of the industry, and the form of its current assets and liabilities.

For example, your business may have current assets mostly made up of cash and would survive with a relatively lower ratio. 

Quick ratio

Quick ratio = Current assets – stock on hand     
                          Current liabilities

Sometimes called the 'acid test ratio', this is one of the best measures of liquidity

By excluding stock which could take some time to turn into cash unless the price is 'knocked down', it concentrates on real, liquid assets. 

It helps answer the question: 

  • If the business doesn't receive income for a period, can it meet its current obligations with the readily convertible 'quick' funds on hand? 

Solvency ratios

Solvency ratios indicate the extent to which the business is able to meet all its debt obligations from sources other than cash flow

It answers the question: 

  • If the business suffers from reduced cash flow, will it be able to continue to meet the debt and interest expense obligations from other sources?

Leverage ratio

Leverage ratio = Total liabilities
                              Equity

The leverage (or gearing) ratio indicates the extent to which the business is reliant on debt financing versus equity to fund the assets of the business

In most cases the higher the ratio, the more difficult it will be to obtain further borrowings.

Debt to assets

Debt to assets = Total liabilities
                            Total assets


This measures the percentage of assets being financed by liabilities

In most cases, this ratio should be less than 1 – indicating adequacy of total assets to finance all debt.

Profitability ratios

These ratios will measure your business performance and ultimately indicate the level of success of your business operations. 

Comparing your net and gross margin calculations to those of other businesses within the same industry will provide you with comparative information, and potentially highlight possible scope for improvement in your margins.

The Australian Tax Office (ATO) provides an app to determine how your business compares to competitors in the same industry.

Gross margin ratio

Gross margin ratio = Gross profit
                                    Total sales


This measures the percentage of sales dollars remaining (after obtaining or manufacturing the goods sold) available to pay the overhead expenses of the business.

Net margin ratio

Net margin ratio = Net profit
                               Total sales

This measures the percentage of sales dollars left after all expenses (including stock), except income taxes

It provides a good opportunity to compare the business's return on income with the performance of similar businesses.

Management ratios  

Management ratios monitor how effectively you're managing your working capital, and determine:

  • how quickly you're replacing stock
  • how often you're collecting debts outstanding from customers
  • how often you're paying your suppliers.

These calculations provide an average that can be used to improve business performance

Comparing your management ratio calculations to those of other businesses within the same industry will provide you with comparative information that may highlight possible scope for improvement in your trading activities.

The Australian Tax Office (ATO) provides an app to determine how your business compares to competitors in the same industry.

Stock days

Stock days = Average stock  x 365
                   Cost of goods sold

This ratio reveals how well your stock is being managed. It's important because it will indicate how long you're holding your stock for. In most cases, the less amount of time stock is held, the greater the profit.

Debtor days

Debtor days = Debtors  x 365
                     Total sales

This ratio indicates how well the cash from customers is being collected – referred to as accounts receivable. If accounts receivables are excessively slow in being converted to cash, the liquidity of your business will be severely affected. 

Creditor days

Creditor days = Creditors  x 365
                         purchases

This ratio indicates how well accounts payable are being managed

If payables are being paid on average before agreed payment terms and/or before debts are being collected, cash flow will be impacted. 

If payments to suppliers are excessively slow, there is a possibility that the supplier relationships will be damaged.

Balance sheet ratios

These ratios will provide an indication of how effective your investment is in the business. The return on assets and investment ratios assess the efficiency of your business resources.

Return on assets

Return on assets = Net profit before tax x 100
                                   Total assets

This measures how efficiently profits are being generated from the assets employed in the business

The ratio will only have meaning when compared with the ratios of others in similar organisations. A low ratio in comparison with industry averages indicates an inefficient use of business assets.

The Australian Tax Office (ATO) provides an app to determine how your business compares to competitors in the same industry.

Return on investment

Return on investment = Net profit before tax x 100
                                                Equity

The return on investments (ROI) is perhaps the most important ratio of all as it tells you whether or not all the effort put into the business is – in addition to achieving the strategic objective –returning an appropriate return on the equity generated.

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