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Ratio Analysis Techniques for Improving Your Small Business
Ratio analysis enables you to spot trends and measure business performance by providing valuable information that allows you to identify and fix problems before your business is affected by them.
Although quantitative analysis can be inherently difficult. There is a basic measure that you as a small business owner can calculate to determine the amount of liquidity (does my business have enough water to cover expenses), activity (does my business activities make a good return) and profit (does my business make the profit margins I expect). Let’s look at these values in detail.
1. Liquidity Ratios – measure your ability to meet your short term goals. Example: you can pay off all your bills today using your balance. For this answer we will use the quick ratio formula.
Quick ratio=assets-current value-current liabilities;
In this example we will use a service business and we will ignore inventory
Let’s say your current assets are $10,000 with $15,000 in cash and $8,000 in common stock.
Your liabilities are $30,000 in accounts payable and $8,000 in notes payable.
Target ratio > 1.1
$33,000 = 0.87
Problem: Your current liabilities are more than your current assets.
Solution: Set new rules for your earnings, or find ways to increase your cash flow. See the numbers never lie, so with this new information you can implement a plan aimed at increasing your current assets.
Next let’s take a look at the workload
2. Workflow – measures how your business’s resources are being used (average collection time, inventory return). In this example we will look at inventory turnover at a discount store ie.99 store.
Inventory Turnover – measures how often inventory is turned over in a given year. The higher the conversion ratio the better. Now to calculate this ratio you will need to know what the ratio of your business is. A quick Google search for your business will provide this information.
Let’s say your cost of goods sold was $150,000 and your inventory on hand was $80,000.
Example: A discount store
Standard Business Ratio 4
Cost of goods sold = $150,000 = 1.9
Problem: Your inventory turnover rate is much slower than the average for your industry.
Solution: Add an automated inventory system that tracks the amount of inventory you have on hand at any given time. So you don’t buy excess inventory. Understanding inventory management is essential to increasing your sales and increasing your profits!
Hopefully at this point you understand how quantitative analysis can improve and help grow your small business.
Finally let’s look at the benefits
3. Profitability Ratios – a group of financial ratios that measure the return on sales and investment
Example: A high-end store that sells high-end products, and your target profit is > 15% of sales. Your annual sales are $350,000. Your net profit after taxes is $60,000
Net profit after taxes = $60,000 = 17.1%
Selling for $350,000
In this example you exceed your profit target by 2%! You make money your business grows and business is good!
As we saw above; Using quantitative analysis is a simple, yet effective way to increase business performance and promote business growth.
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