Financial Ratios

Do you review your financial statements?  Many business owners only look at the revenue and net profit numbers.  It is essential that you also understand your balance sheet and your ratios to understand the financial health of your business.  

Here are some financial ratios that are important in determining the success or general health of your restoration business. 

Financial Ratio Analysis

Financial ratio analysis is performed by comparing two items in the financial statements. The resulting ratio can be interpreted in a way that is more insightful than looking at the items separately.

Financial ratios can be classified into ratios that measure: (1) profitability, (2) liquidity, (3) management efficiency, (4) leverage, and (5) valuation & growth.

List of Financial Ratios

Here is a list of various financial ratios. Take note that most of the ratios can also be expressed in percentage by multiplying the decimal number by 100%. Each ratio is briefly described.

Profitability Ratios

1. Gross Profit Rate = Gross Profit ÷ Net Sales

Evaluates how much gross profit is generated from sales. Gross profit is equal to net sales (sales minus sales returns, discounts, and allowances) minus cost of sales.

2. Return on Sales = Net Income ÷ Net Sales

Also known as “net profit margin” or “net profit rate”, it measures the percentage of income derived from dollar sales. Generally, the higher the ROS the better.

Liquidity Ratios

1. Current Ratio = Current Assets ÷ Current Liabilities

Evaluates the ability of a company to pay short-term obligations using current assets (cash, marketable securities, current receivables, inventory, and prepayments).

2. Acid Test Ratio = Quick Assets ÷ Current Liabilities

Also known as “quick ratio“, it measures the ability of a company to pay short-term obligations using the more liquid types of current assets or “quick assets” (cash, marketable securities, and current receivables).

3. Net Working Capital = Current Assets – Current Liabilities

Determines if a company can meet its current obligations with its current assets; and how much excess or deficiency there is.

Management Efficiency Ratios

1. Receivable Turnover = Net Credit Sales ÷ Average Accounts Receivable

Measures the efficiency of extending credit and collecting the same. It indicates the average number of times in a year a company collects its open accounts. A high ratio implies efficient credit and collection process.

2. Days Sales Outstanding = 360 Days ÷ Receivable Turnover

Also known as “receivable turnover in days”, “collection period”. It measures the average number of days it takes a company to collect a receivable. The shorter the DSO, the better. Take note that some use 365 days instead of 360. 

Leverage Ratios

1. Debt Ratio = Total Liabilities ÷ Total Assets

Measures the portion of company assets that is financed by debt (obligations to third parties). Debt ratio can also be computed using the formula: 1 minus Equity Ratio.

2. Debt-Equity Ratio = Total Liabilities ÷ Total Equity

Evaluates the capital structure of a company. A D/E ratio of more than 1 implies that the company is a leveraged firm; less than 1 implies that it is a conservative one.