18 Financial Ratios Every Business Owner Needs to Know

18 financial ratios you should know about by Talibro Small Business Accounting Software

Another N-items-you-should-know type of article must be really bugging you out. To get things straight, there won’t be N+1, at least we won’t be covering advanced statistics in this article and you will be able to better understand your business state and performance based on your financial statements.

1 – Net profit

Net profit shows if there is any money left after deducting your expenses. The positive net profit can be used to refinance to the company growth.

Net profit (amount) = Net Sales (amount) – Total costs (amount)

2 – Net profit margin

Net profit margin is a Net profit over  Net Sales. Low net profit margin can indicate too high operating costs or a wrong pricing structure. It is best to compare over time and against other companies in the same industry

Net profit margin = (Net profit / Net Sales) * 100

3 – Gross profit margin

The gross profit margin shows how much from each dollar of a company’s revenue is left after taking away the cost of goods sold. A profit margin of 20% indicates that for each dollar of sales, the company spent 80 cents in direct costs to produce the goods or services the company sold.

Gross profit margin = ( (Net Sales – Cost of goods sold) / Net Sales) * 100

4 – Operating profit margin

The ratio provides insights into a company’s operating efficiency and pricing strategy. It tells how much money a company makes on each dollar of sales before interest and taxes excluding extra ordinary income and expense. High Operating profit margin shows that acompany is managing its operating costs well.

Operating profit margin = (Earnings before interest and taxes / Net Sales)*100

5 – EBITDA

First used in the 1980s, EBITDA (Earnings before interest and depreciation and amortization) is of particular interest to companies with large amounts of fixed assets and or intangible assets which are subject to heavy depreciation.

EBITDA is a measure of company’s operational profitability over time, but taking out the potentially distorting effects of changes in interest, taxes, depreciation and amortization, which can be all manipulated by financing and accounting decisions.

EBITDA = Net Sales – Expenses (excluding interest, tax and depreciation and amortization)

6 – Revenue growth rate

Revenue growth rate is a simple but an important measure.

Revenue growth rate = ( (Net Sales – Net Sales from earlier period)/Net Sales from previous period) *100

7 – EVA (Economic Value Added)

EVA is a measure of profit that exceeds investor expectations. Basically it is a profit earned by a company less the cost of financing the company’s capital.

EVA = Net operating profit after tax – (Weighted average cost of capital * (Total assets – Current Liabilities)

8 – Total shareholder return (TSR)

TSR represents the change in capital of a company over a period of time for a listed company. TSR is an easy way to compare performance of similar companies.

TSR = ( (Share price at the end of period t – Share price at the beginning of period t) + Dividends)/Share price at the beginning of period t

9 – Return on Investment (ROI)

ROI, also referred to as a rate of profit that measure the efficiency of an investment before or after capital allocation. By comparing ROI of various projects, one can prioritize investment options by the highest ROI to the lowest.

ROI = ( ( Gain of investment – Cost of investment) / Cost of investment )* 100. For example, if the cost of shares bough was $100, and now you can sell for $150, ROI equals 50%.

10 – Return on capital employed (ROCE)

ROCE is a measure of how well the management has used the investment made by owners and creditors into the business. The higher the ROCE, the more efficient the firm is in using its funds.

ROCE = (Earning before interest and tax)/Capital investment required for the company to function and grow.

11- Return on assets (ROA)

ROA measures how efficiently a company is using its assets at its disposals. Low ROA indicates that the income has been low compared to the amount of assets owned.

ROA =  ( Net profit / Total assets ) * 100

12 -Return on Equity (ROE)

ROE measure how much profit a company is generating from the money shareholders have invested and is also considered the single most important financial ratio for investors and to measure the management team performance.

High ROE means that there is less of a need to borrow more and from elsewhere.

ROE = ( Net profit / Average shareholder’s equity) * 100

Frequency: Annually and quarterly

13 – Debt-to-equity (D/E) ratio

D/E ratio measures the proportion of debt and equity financing of a company. The higher the ratio, the riskier is the company due to high leverage.

D/E ratio = Total liabilities / Total equity

Frequency: Annually and quarterly

14 – Cash conversion cycle (CCC)

CCC asses the length of time, it takes for an organization to convert resource into cash flow. The metric captures three steps:

  1. the amount of time needed to sell inventory
  2. the amount of time needed to collect receivables
  3. the length of time (in days), the company can accord not to pay the bills without incurring penalties
CCC = Days inventory outstanding+ Days sales outstanding – Days payable outstanding
Days inventory outstanding = Average inventory outstanding / Cost of sales per day
Days of sales outstanding = Average accounts receivable / net sales amount per day
Days payable outstanding = Average accounts payable / cost of sales per day
Frequency: Annually and quarterly

15 – Working Capital Ratio

This is another kpi to help understand the cash position and measure liquidity.
Working capital ratio indicates whether a company has enough short-term assets to cover its short-term debt. The higher the ratio, the higher the liquidity of the company.
Working capital ratio = Current assets / Current liabilities
Frequency: Quarterly

16 – Operating Expense Ratio (OER)

OPEX provides an insight into how expensive it is to run the business and measures the income spent on day-to-day operational expenses.
OER = (Operating expenses / Net sales) * 100
Frequency: Monthly and quarterly

17 – CAPEX to sales ratio

When you compare CAPEX (Capital expenditures, such as acquiring fixed assets, equipment, property, etc.) to sales, it implies how much a company is investing for the future. This ratio matters more to manufacturing entities more than to service companies.
CAPEX ratio = ( Capital expenditures / Net sales ) * 100
Frequency: Quarterly,  six-monthly

18 – Price/earnings ratio (P/E ratio)

P/E ratio is the most popular metric of stock analysis and looks at the relationship between the stock price ad the company’s earnings.
A higher P/E ratio means that investors are paying more for each unit of net income, making it more valuable than a company with a lower P/E ratio.
P/E ratio = Current market capitalization / Earnings for the company for the year

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