I spent an enjoyable day with a dynamic client today and we got to talking about the importance of being able to interpret financial statements and benchamrk results against industry standards to provide some strategies for business growth – so here is a list of some of the things I spoke about with the client today
Financial Ratios
Financial ratios assist to measure where your business currently stands, where it’s been and where it’s heading. They also help you measure yourself against industry benchmarks, and see how you’re tracking against your business plans – there are a number of ratios you can use but some of the common ones are
Gross Profit Margin – gross profit/sales – assesses the profitability of products/services prior to operating expenses – if you sell more than one product/service you should have them listed out in your records so you can assess them more easily – there could be products/services that are bringing your margins down and likewise it could show that you need to concentrate on the more profitable deliverables in your businesses
Operating Expense Ratio – total expenses/total sales – for every dollar of revenue you earn what is spent on operating expenses
Net Profit Margin – net income/sales – this shows you in percentage terms the profit your business makes for every $ of income after covering all your operating expenses
Current ratio – current assets/current liabilities – this helps to measure the solvency of your business by assessing whether your current assets (unpaid bills, cash at bank etc) is enough to meet your current liabilities (unpaid bills, tax laibilites, short term loans etc) as a rule of thumb many banks like this ratio to be 2 or more(in other words your assets are double that of your liabilities) which means you have ample capacity to meet your liabilites
Inventory turnover – cost of goods sold/inventory – if you sell products then this is a good measure is shows how many times your trading stock is “turned over” (sold and restocked)during a specific period so for example if you spend $100 000 on stock and keep say $10 000 worth of stock on hand then you are turning your inventory over 10 times a year – low figures may means you have money tied up in stock that is not moving and could affect cashflow and higher figures may mean you are not keeping enough trading stock on hand
Return on Owners Equity – net income/owners equity – this measures how much your making on the investment you have put into your business – so say you invested $100 000 worth of capital into the business and the business generated net income of $50 000 then your return on owners equity is 50% – this is a great way of comparing whether the investment you have made in your business is comparable to what you may have earned if you had put your money into another investment
There are many other ratios you can use to measure performance and efficiency over time such as
- Accounts payable turnover
- Accounts Payable period
- Accounts receivable turnover
- Total debt ratio
Remember you cannot manage what you cannot measure
Being able to benchmark your business against industry standards can give you some valuable insight into your business. You can use these benchmarks to help formulate plans for a new business or to employ strategies for a business growth, set targets, improve business performance. The link below provides a number of products such as industry profiles (around $220 per profile) and small business analysis
www.benchmarking.com.au
I hope this information will assist you in measuring the performance of your business
Good Luck
Cheers
Leanne