As you start your own business, financial ratios should never be overlooked. Here are a few important concepts and terms to keep in mind to make sure you stay on top of your finances.
“There are many ratios to look at. The most important ones are ratios that have to do with the balance sheet,” said Robert M. Pesce Jr., Partner-in-Charge of Accounting Services at Marcum LLP. “The common ratio we deal with for small businesses is the current ratio, [which] measures current assets to current liabilities: you don’t want that to be less than one to one.You want your current assets to be no less than your current liabilities. A healthy firm will be closer to 2 to 1, meaning you’ll have twice as much assets as liabilities.”
“Companies should also look at their receivables, since everyone is taking longer to pay. That’s DSO (days sales outstanding)," said Pesce. "You’d like to collect your account receivables within 45-60 days. It’s ideal to get them within 30 days. It also depends on the industry -- if you’re in the business of selling perishables, your DSO will be lower.”
According to Pesce, if you know what your monthly sales are running, your accounts receivable should not be more than twice your monthly sales; this is called the receivable turnover ratio, or working capital ratio. Working capital is the difference between your current assets and your current liabilities. The working capital ratio is current assets divided by current liabilities.
Consider this piece of advice, as well. “You also hear about ROI (return on investment)," said Pesce. “A small business owner isn’t concerned with that. Their company is their investment. ROI is used for shareholders.”
Some Terms To Remember:
Leverage Financial Ratios show the percentage of a company’s capital structure that is made up on debt or liabilities owed to external parties.
Liquidity Financial Ratios show the solvency of a company based on assets versus its liabilities.
Operating Financial Ratios show the efficiency of management and a company’s operations in utilizing its capital.
Profitability Financial Ratios measure the return earned on a company’s capital and the financial cushion relative to each dollar of sales.For more information, please visit the Financial Ratio tool on the OPEN Forum