Measuring Business Health
It is very easy to be caught up in the day-to-day running of your business and lose sight of the bigger picture. Taking stock of your business health is important. Knowing exactly where you are will allow for better planning strategies, early warnings for any issues, and opportunities to chart better courses for the success of your business.
To help gauge your business health there are some quick ratios that can help. Accorti Accountants + Advisors can help you assess the health of your business and explain how you can calculate these checks.
1. Liquidity Ratios
The liquidity ratio calculates how quickly you can convert the assets of the business into cash – this helps assess if you are able to pay the business bills.
The higher the ratio the better, this means that the business has more assets than liabilities.
Current ratio = Total current assets / Total current liabilities
Dependent on the type of industry the business is in, and nature of the business assets and liabilities, a general guide, 2:1 is a good current ratio.
Quick ratio = (Current assets – stock on hand) / Current liabilities
The quick ratio excludes existing stock from the calculation, which may not be converted quickly to cash. This ratio is a more realistic snapshot of the business position.
2. Solvency ratios
Solvency ratios look at sources besides cashflow to assess the business ability to settle outstanding debts.
Leverage ratio = Total liabilities / Equity
This ratio measures if the business is reliant on equity or debt finance to fund assets. Higher ratios will make it more difficult to borrow money.
Debt to assets
Debt to assets = Total liabilities / Total assets
This calculates the percentage of assets that are being financed by the business liabilities.
3. Profitability ratios
Profitability ratios calculate the efficiency of business operations. If possible, it is recommended to measure against other businesses in the same industry.
Gross margin ratio
Gross margin ratio = Gross profit / Total sales
The gross margin ratio will tell you if your business can cover the business overhead costs from the sales income.
Net margin ratio
Net margin ratio = Net profit / Total sales
This ratio calculates the percentage of sales dollars remaining after your expenses have been settled (except income taxes).
Giving your business health a regular check up is a good habit to get into. Using the ratios will help you to understand the current health of your business and will allow you to plan for the future. Talk to the team at Accorti Accountants +Advisors about how to calculate these ratios to keep your business heading on the right track.