Financial statements can serve as an early warning signal to
business problems or opportunities that need your attention. Learn
how to calculate and use key financial ratios to compare changes in
your company’s performance.
Financial statements can serve as an early warning signal to business problems or opportunities that need your attention. Learn how to calculate and use key financial ratios to compare changes in your company’s performance.
All businesses can benefit from tracking certain ratios. If you are intimidated or confused by the concepts, don’t be embarrassed to ask your accountant for help. Ask every month, if necessary, until you finally get comfortable with the information. It’s the change in your business ratios and a comparison of the ratios to other businesses in your industry that should assist you in making sound business decisions.
Here are four common business ratios.
Gross profit margin This ratio is computed by dividing gross profit by net sales. Gross profit is the difference between sales and the cost of goods sold.
Net profit percentage This is computed by dividing net profit by net sales. Unincorporated businesses should make an allowance for the owner-manager’s compensation before making industry comparisons.
Operating expense ratio This is computed by dividing the operating expenses by net sales. An increase in this ratio from one period to the next should serve as a warning to management.
Return on investment This is computed by dividing net profit by total equity (assets minus debts). This measures the overall profitability of the company. A large ratio which increases annually is, of course, desirable.
You can use ratios to help make decisions which will increase the profitability of your company. For assistance in collecting information you can understand and use in your business, contact us.
