One look at these formulas and you may feel like your back in high school algebra class! Well, your teachers said you’d use this stuff in real life, now you have the best reason of all -to gain a clearer understanding of your business.
There are dozens of ratios that accountants use to analyzing the financial health of your company in the areas of liquidity, efficiency, profitability and solvency. Here we will look at some of the most common ratios from each category.
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Current Ratio = Current Assets/ Current Liabilities
Used to measures your companies liquidity, or ability to quickly generate cash. This ratio is one of the most commonly calculated and is important because it helps you to assess the business’ ability to meet short-term debt obligations. Lenders also commonly look at this ratio.
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Days Sales Outstanding = # Days / (Sales/Accounts Receivable)
Also known as “DSO” or “Average Collection Period”, this is one of several key ratios used to measure your company’s efficiency. The Days Sales Outstanding calculates the average days it takes to collect payment on your accounts receivable. This is a great way to keep an eye on collections efforts, the key to cash flow.
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Gross Profit Margin = Gross Profit /Net Sales
Gross profit margin is one of the most universally recognized ratios used in business. Reported as a percentage, this profitability ratio measures the % of sales dollars remaining after deducting the cost of goods sold. A negative trend in the margin signals that inventory and/or cost & pricing matters require review.
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Debt Ratio = Total Liabilities / Total Assets
The solvency ratio is used to measure the company’s ability to satisfy long-term debt when it becomes due. The Debt Ratio measures the percentage of business assets financed with debt. It is generally believed that a healthy Debt Ratio should be no more than 50%. A higher ratio may indicate overuse of debt and may result in difficulty meeting debt obligations.
