Ratios 101: Key Indicators for any Business

The health of any company depends on several factors. However, a single glance at earnings figures or expenses does not provide enough information to make a firm determination about that company's viability. For example, Company A shows $1 million in sales of computers during Year 1 of operation. In Year 2, this increases to $2 million, twice that of Year 1. So, an increase in sales is always good, right? Not necessarily. In the case of Company A, the business sold fewer units overall, incurred greater expenses, and therefore had overall lower profitability.

A better barometer to gauge the health of any business is the assessment of certain key financial ratios that check various aspects of a company's financial performance.

Debt/Equity:
Dividing a company's total liabilities or debt by the amount of shareholders' equity generates the Debt/Equity ratio of a company. This measures the amount of equity and debt incurred by a company to finance its assets.

A high debt/equity ratio could mean that the company uses a higher percentage of debt to fund operations, as opposed to funding operations through equity. Conversely, if the debt used to fund operations is less than the earnings generated by using it, then it is beneficial to the shareholders.

In addition, if debt financing costs prove to be higher than the cumulative returns, it can lead to an unstable situation for the company and affect future prospects.

Assets/Liabilities:
This is also called the Assets/Debt ratio. The assets/liabilities ratio measures the percentage of assets financed through debt. It is calculated by dividing the total debt or liabilities of a company by its total assets. It is different from the Debt/Equity ratio where debt is divided by the amount of shareholders' equity.

This ratio provides a measure of the company's short-term liquidity. A healthy asset to liability ratio is one where there are twice as many assets as liabilities. A higher proportion of debt indicates poor financial health.

Profit margin (Net Income/Sales):
The profit margin ratio reveals the profitability of a business or the amount of profit earned per dollar of sale. It is calculated by dividing net income by the total revenue, resulting in a percentage. Thus, a profit margin of 16% means that the company made a profit of $0.16 per dollar. In this ratio, net income is defined as the difference between revenue and cost.

This ratio is valuable when conducting comparisons of similar companies. Profit margin shows whether the company's pricing strategy is viable or not. Higher margins indicate better control over pricing. Also, profit margins are a better comparison metric than total earnings, as profit margins take into consideration operating costs and inventory expenses.

Inventory Turnover:
The inventory turnover ratio reveals the speed at which a company moves its inventory. To calculate inventory turnover ratio, divide total sales by figures of average inventory for the period you are evaluating.

A high turnover ratio indicates that the company is moving inventory at a rapid pace, or managing good sales, whereas as a lower ratio could point to inventory not converted to sales, or a poor return on investment. Inventory movement can also be dependent on particular seasons. Hence, average figures are considered when comparing financial health of different companies.

Return on Assets:
The return on assets ratio reveals the profitability of a company's total assets. The ratio proves useful when assessing the viability of using the company's assets in generating revenue. The return on assets is calculated by dividing net income, or revenue earned, by the total amount of assets owned. When evaluating this ratio, it is important to remember that it is dependent upon the industry in which the company operates. Also, if a company incurred a heavy initial investment, it will have a lower return on its assets.

Consistent monitoring of these key ratios should provide you with adequate information to assess whether or not your business is on the right track, financially.

Satish Patel, CPA
President, Analytix Solutions
Satish Patel, Founder-CEO of Analytix Solutions, has more than two decades of experience as a CPA. He has also advised small and mid-sized businesses on diverse matters such as valuation, accounting, and finance. His experience extends to raising capital and arranging for finance from angel investors.

Accurate Bookkeeping System, Reliable Accounting

In a small business, the terms accounting and bookkeeping may be used interchangeably; but each of them has well-defined functions. A well-maintained bookkeeping system is a necessity for the accounting system to function properly, which in turn supports the smooth functioning of the business offerings and its deliverables.

Bookkeeping Functions

The range of functions that falls under bookkeeping is vast. It must be mentioned here that if you're looking for an efficient accounting system, a business must perform certain functions on a daily basis. The foremost among these being recording income and tracking expense. These are entries that the accounting system will build up on, for tracking finances as well as for tax reporting.

An ideal bookkeeping system includes the following tasks:

- Keeping track of all financial transactions of the company such a purchases, sales, payments made, and payments received
- Recording income, cash outflow, and bank transactions of the company
- Reconciling bank accounts, keep track of deposits in the account, writing check, and keeping banking reports updated
- Preparing and maintaining reports such as the income statement and the company's balance sheet

These records, collectively, provide the basis for sound accounting processes in the company. More importantly, the bookkeeper's work allows the accountant to prepare reports for declaring income and filing taxes with the government.

Small business and Bookkeeping

In a small business, resources are limited; it is possible that the business owner or partners themselves function as bookkeepers and accountants as well. A significant disadvantage with this system of accounting and bookkeeping is that because owners and partners are also concerned with managing client deliverables and ensuring sustenance for the business, they may not be able to ensure 100% accuracy in record-keeping at all times.

A viable option for small businesses or companies with limited resources is outsourcing. Locating a trustworthy vendor or accounting and bookkeeping services provider can go a long way in ensuring:

- Accuracy in accounts
- Accurate reports for tax purposes, and
- Less chances of monetary losses as a result of a recording lapse.

Outsourcing saves a huge amount of money that would otherwise go into setting up and maintaining an entire department, complete with infrastructure and manpower. More importantly, depending on your needs, a vendor will ensure high-quality work on time.

Interested in learning more about accounting and bookkeeping outsourcing? Ever outsourced your support functions previously? Share your experience with us, we would love to hear from you.

Satish Patel, CPA
President, Analytix Solutions
Satish Patel, Founder-CEO of Analytix Solutions, has more than two decades of experience as a CPA. He has also advised small and mid-sized businesses on diverse matters such as valuation, accounting, and finance. His experience extends to raising capital and arranging for finance from angel investors.

Financial Reports vs. Operational Reports: Do You Know the Difference?

Critical to the success of any small to mid-sized business is financial stability. As a business owner, you should be able to discern which indicators determine financial stability and which indicators warn of financial challenges ahead. All of this information can be gathered from regular reviews of your financial and operational reports. Both contain key data and information that business owners need to know, but these reports serve different purposes.

Financial reports track how much money your business is making and how you are spending that money, as of a specific period in time. As a business owner, you obviously want to know this information. However, there are additional stakeholders or potential stakeholders that may need to know this information as well, such as investors or creditors. Examples of various financial reports are a balance sheet (which summarizes a company's assets and liabilities), an income statement (which indicates how much profit a company generates), and a cash flow statement (which shows a company's sources and uses of cash). Financial reports show historical data, but they provide insight into how a business spends its profits, whether they are reinvested into the business, and whether the company can sustain future growth.

Operational reports provide business intelligence on how efficiently a company performs. These reports allow companies to evaluate its current and future financial situation. With the correct systems and tools in place, operational data can be tracked real-time so that businesses are able to react and adjust their practices effectively. Business owners should review operational reports daily. These reports can vary by industry. Restaurants may need to track average time per table/meal, whereas hotels may need to track occupancy rates. Actions taken by business owners resulting from this garnered business intelligence can have an immediate, dramatic impact on productivity and ultimately profitability.

As a small or mid-sized business owner, keeping tabs on both your financial and operational reports will help you run your business more effectively. We are currently offering a free analysis of your business processes and accounting system, which could help you to better prepare and understand your financial and operational reports. If you would like to learn more on how Analytix Solutions can help move your business forward, please call me directly at 781.503.9004 or email me at sales@aixsol.com.

Satish Patel, CPA
President, Analytix Solutions
Satish Patel, Founder-CEO of Analytix Solutions, has more than two decades of experience as a CPA. He has also advised small and mid-sized businesses on diverse matters such as valuation, accounting, and finance. His experience extends to raising capital and arranging for finance from angel investors.