Financial Ratios Key Performance Indicators
1.0 Introduction
The following are financial ratios that the owner needs to know. The benefit of knowing how to calculate and understand the ratios will inform you on how your money is working for you, indicate what type of return the Company produces for money invested, and indicate the financial health of the operation.
2.0 Efficiency Ratios:
Efficiency ratios indicate how well your money is working for you. Are your assets efficiently applied?
| RATIO TYPE: | CALCULATION: | DEFINITION: |
| Net Worth | Total Assets – Total Liabilities (i.e., Equity) |
Net worth is the amount of assets a business holds less than all outstanding obligations. You can calculate net worth by subtracting total assets from total liabilities, or you can look at the net worth section of the balance sheet. Net worth may be labeled as net assets, stockholders’ equity, or partner capital, depending on the type of business. |
| Collection Period (AKA DSO) | (Accounts Receivables x 365) / Sales | Reflects how long it takes you to collect the money that is owed to the Company. The number of days that are reasonable to collect depends on the industry. |
| Assets to Sales | Total Assets / Sales | The ratio is a quick look at the dollars devoted to driving sales (revenue). How expensive is it to produce a dollar of sales? What resources does the Company have tied to produce that amount of sales? 50% is good; lower is better. |
| Quick Ratio | (Cash + Accounts Receivable) / Total Current Liabilities | A measure of the amount of liquid assets available to offset the current debt. Do not count receivables over 90 days. 1.0 or higher is considered healthy. |
3.0 Solvency Ratios:
Solvency ratios indicate the financial health of the Company’s operation. Lending financial institutions utilize this ratio in determining whether or not to lend the Company money. These institutions want to know how solvent the Company is, and if you have money to pay bills.
| CASH FLOW | ||
|---|---|---|
| RATIO TYPE: | CALCULATION: | DEFINITION: |
| Current Ratio A.K.A Working Capital | Total Current Assets / Total Current Liabilities | A measure of the degree to which current assets cover current liabilities. Measures the margin of safety present to cover any possible reduction in current assets. How secure is the Company? Is the Company a good risk to lend money to? Low or declining ratios may indicate an insufficient margin of safety for meeting current obligations. High ratios may indicate surplus or unproductive cash and/or inventory. A ratio of 2.0 or higher is a comfortable position. |
| Current Liabilities to Net Worth | Total Current Liabilities / Net Worth | A measure of the extent to which the corporation is using creditor funds versus their own investment to finance the business. A ratio of .5 or higher may indicate inadequate owner investment or an extended accounts payable period. Care should be taken not to offend your vendors/creditors to the extent it affects your ability to conduct day-to-day business. |
| RATIO TYPE: | CALCULATION: | DEFINITION: |
| Fixed Assets to Net Worth | Fixed Assets / Net Worth | A measure of the extent of the Company’s investment in non-liquid and often overvalued fixed assets. A ratio of .75 or higher is usually undesirable as it indicates possible over-investment and causes a large annual depreciation charge that will be deducted from the income statement. |
| Fixed Assets to Total Assets | Fixed Assets / Total Assets | A measure of the extent to which fixed assets are financed with owners’ equity (capital). A high ratio, .5 or higher, indicates an inefficient use of working capital which reduces the company’s ability to carry accounts receivable. This will often limit your ability to respond to increased demand for your services or products. |
| FINANCIAL POSITION | ||
|---|---|---|
| RATIO TYPE: | CALCULATION: | DEFINITION: |
| Return On Investment | Owners Profit / Net Worth | Company earnings for every dollar the owner has invested. |
| Debt to Net Worth | Total liabilities / Net Worth | Creditors Investment for every dollar of the owner’s investment. |
| Debt service coverage ratio: | Income / Annual Cost of Loan Payments | Calculated by dividing your company’s annual net income by your annual debt service, or more simply, your loan payments. |
| PRODUCTIVITY | ||
|---|---|---|
| RATIO TYPE: | CALCULATION: | DEFINITION: |
| Sales / Employee | Total Sales / Total Employees | |
| Labor Productivity | Revenue / Labor Hrs. |
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| Staff Costs Per Employee | Non-Owner wages, Taxes, Benefits / Total Employees excluding owner | |
| Store Sales / Square Ft. | Sales $’s / Store Square Ft. | Best use of available display and storage space |
| Costs of Dispensing | Total Costs of Dispensing / Total Product | |