Xero Accounting Gold Champion Partner
We hope you enjoy reading the blog post.
If you want our team to do your accounting or tax for you click here.

7 Ratios Every Business Should Know

There is a saying that says you can only manage what you measure…the only way to manage your business finances is through some key ratios…


There are some key ratios every business should know to understand the viability and health of your business. Managing your business’ finances and revenues can be a full-time job, and you might even have a full-time accountant on staff to handle the books. Many small business owners, however, prefer to handle this aspect of their businesses themselves, foregoing an accountant to maintain control over their own books.

The access to information is therefore not the real issue seeing that it is produced either by yourself or your accountant. It is the timing in which it is produced and the use of the data that often leaves businesses falling short when it comes to strategic decision making.

Here are some standard accounting formulas you should know. These formulas are generally regarded as universal to any business and will provide you with the figures you need to understand the viability and health of your business. Ratio analysis can get way more complicated and in-depth, but getting a grip on these as a starting point will already move you closer to achieving your goals.

7 Ratios Every Business Should Know

1. The Accounting Equation

Equation: (Assets = Liability + Owner’s Equity)

What It Means:

  • Assets are all the things your company owns, including property, cash, inventory and equipment that will provide you with a future benefit.
  • Liabilities are obligations that you must pay, including things like lease payments, merchant account fees and debt service.
  • Owner’s Equity is the portion of the company that actually belongs to the owner.

2. Net Income

Equation: (Revenues – Expenses = Net Income)

What It Means:

  • Revenues are the sales or other positive cash inflow that comes into your company.
  • Expenses are the costs that are associated with making sales.
  • By subtracting your revenue from your expenses, you can calculate your net income. This is the money that you have earned at the end of the day. It’s possible that this number will be negative when your business is in its infancy stage, so the goal is for your business’ net income to become positive, meaning your business is profitable.

3. Break-Even Point

Equation: (Break-Even Volume = Fixed Costs / Sales Price – Variable Cost Per Unit)

What It Means:

  • Fixed Costs are recurring, predictable costs that you must pay to conduct business. These costs include insurance premiums, rent, employee salaries, etc.
  • Sales Price is the retail price you sell your products or services for.
  • Variable Cost Per Unit is the amount it costs you to make your product.
  • If you divide your fixed costs by the sale price of your product, minus the amount it costs to make your product, you’ll have a break-even point, which tells you how much you need to sell to cover all your costs.

4. Cash Ratio

Equation: (Cash Ratio = Cash / Current Liabilities)

What It Means:

  • This gives you an idea of how much cash you currently have on hand.
  • Cash is simply the amount of cash you have at your disposal. This can include actual cash and cash equivalents (i.e. highly liquid investment securities).
  • Current Liabilities are the current debts the business has incurred.
  • This ratio demonstrates how well your business can pay off its current liabilities. In this case, the higher the number, the healthier your company.

5. Profit Margin

Equation: (Profit Margin = Net Income / Sales)

What It Means:

  • Net Income is the total amount of money your business has made after expenses have been removed.
  • Sales are the total amount of sales you’ve generated.
  • When you divide your net income by your sales, you’ll get your organization’s profit margin. A high profit margin indicates a very healthy company. A low profit margin can reveal how unsuccessful a company might be, but it can also mean that your organization doesn’t handle its expenses well. Remember that your net income is made up of your total revenue minus your expenses. If you have high sales revenue, but still have a low profit margin, it might be time to look at the figures making up your net income.

6. Debt-to-Equity Ratio

Equation: (Debt-to-Equity Ratio = Total Liabilities / Total Equity)

What It Means:

  • Total Liabilities include all the costs you must pay to outside parties, such as loan or interest payments.
  • Total Equity is how much of the company actually belongs to the owner or other employees. In other words, it’s the amount of money the owner has invested in his or her own company.
  • A high debt-to-equity ratio illustrates that a high proportion of your company’s financing comes from outside sources, such as banks. If you’re attempting to secure more financing or looking for investors, a high debt-to-equity ratio might make it more difficult to land funding.

7. Cost of Goods Sold

Equation: (Cost of Goods Sold = Cost of Materials/Inventory – Cost of Outputs)

What It Means:

  • Cost of Materials/Inventory is the amount of money your company should spend to secure the necessary products or materials to manufacture your product.
  • Cost of Outputs is the total cost of the goods sold.
  • By subtracting the cost of outputs from the cost of materials, you’ll know your cost of goods sold. This tells you if the costs you’re paying to make your product are in line with the revenue you earn when you sell it.

There are many more accounting formulas that you can use, but these seven are some of the more common. It’s best to have a good grasp of these formulas even if you’re not planning to manage your own accounting. The more knowledge you have regarding your finances, the better you can manage your business.

 

 

 

Facebook
Twitter
LinkedIn
WhatsApp
Ready to take your financial success to new heights?
How would it feel to have peace of mind knowing that your finances are in the hands of experienced professionals who are passionate about helping you maximise your financial potential?
Ready to experience the difference? Contact us today for a complimentary consultation and discover how our tailored accounting solutions can empower your financial future.
What our clients say?
Thrive CFO
5.0
Based on 10 reviews
powered by Google
Martin Mulder
Martin Mulder
12:36 17 Aug 23
I have only the greatest appreciation for this company. I was going through a difficult time and they were understanding and accommodating. My tax was handled speedily and efficiently.
Kevin Rademeyer
Kevin Rademeyer
07:20 17 Aug 23
We have been using Melissa, Marche and the rest of the crew at ThriveCFO for over 10 years, in order to compile our annual audit for Law Society. They have been exceptional, efficient and pro-active every year. I would not take the business anywhere else.
Jan de Wit
Jan de Wit
13:13 13 Jun 23
Our firm has been making use of the services of Thrive CFO for more than 10 years. Thrive CFO has amazing staff that is not only extremely helpful, but also very capable. We are extremely happy with their services and will continue to support them. They make accounting easy. Thanks Melissa, Marche and the rest of the Team - You Rock!!
LM Keyser
LM Keyser
07:13 13 Jun 23
The ThriveCFO team has been our trusted accounting and tax partner since 2010. They are competent, honest, approachable, quick to respond, and they really do care. I highly recommend them.
Andre Claassen
Andre Claassen
10:24 08 Jun 23
Prompt, professional and personal service!!
Palabadi Ramaphoko
Palabadi Ramaphoko
19:38 15 May 23
I'm impressed with the work you do. You are extremely professional and polite. I hope we will grow big together!
Deidre Oosthuysen
Deidre Oosthuysen
12:20 04 May 23
I feel as though Thrive CFO is a natural part of our business. 100% professional. Very knowledgeable. Incredibly organised. And with a work ethic and proactive communication practices, I know I am in the very best hands possible.
Sean Fabian
Sean Fabian
07:45 04 May 23
As someone who has had the pleasure of working with Thrive CFO, I can confidently say that they are an exceptional company with an unwavering dedication to their clients. From beginning to end, their commitment to providing top-tier financial services is evident in every interaction.One of the things that sets Thrive CFO apart is their focus on education. They take the time to educate their clients on financial best practices and help them understand the reasoning behind their recommendations. This approach ensures that clients are empowered to make informed decisions about their finances.Thrive CFO also uses the latest technology to streamline their services and make the financial management process as efficient as possible. They utilize cloud-based software to provide real-time financial data and make it easy for clients to access their financial information at any time.Overall, Thrive CFO is an exceptional company that is dedicated to providing personalised financial solutions that help their clients succeed. If you're looking for a financial firm that truly cares about your success, I highly recommend Thrive CFO.
Michael Dawson
Michael Dawson
15:48 02 May 23
Great experience with the team! Always willing to assist with questions and able to help guide my small business to ensure that I am compliant.
Riaan Schlebusch ITMC
Riaan Schlebusch ITMC
12:15 21 Apr 23
Professional, smart and friendly people.You only deal with the best of the best, and they know how to answer your questions, and they ensure that they understand you, and make they make sure to take the time to know your business.
See All Reviews
js_loader

Ready To Take Your Financial Success To New Heights?

Scroll to Top