Think Ratio-ly

You can't know your homebased business unless you know these five financial ratios.
This story appears in the October 1999 issue of Startups. Subscribe »
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If your reaction to financial ratios is "Who cares?" don't go another day without reading an online article by Tom Nunnally, senior vice president at Enterprise Bank. The article cites several financial ratios every small-business owner needs to know. "Eighty-five percent of small-business owners can become so immersed in their daily operations that they fail to see adverse trends developing," Nunnally writes, going on to call financial ratios the "impartial indicators" of business finance trends, and likening ratios to "pressure gauges that should be read at least once a year."

Don't be intimidated by the mathematical term-financial ratios don't have to be particularly difficult, according to Nunnally, who considers the following ratios relevant to any small business:

1. Current ratio: a measure of your company's ability to pay current liabilities when due.

2. Profitability ratio: calculated by dividing net profit by sales; the result is your profit, expressed as a percentage of sales.

3. Debt-to-worth ratio: calculated by dividing total debt (current and long term) by net worth (equity)-an especially important ratio to your banker or other lender.

4. Inventory turnover ratio: calculated by dividing annual cost of goods sold by inventory, which can be divided into 360 to express inventory in days.

5. Payable turnover ratio: measures a company's performance with trade credit, an important source of low-cost financing. The ratio is calculated by dividing purchases by accounts payable (which can be further divided into 360 to express payables in days).

The article includes an in-depth look at each of these ratios, with do-it-yourself instructions. And for tons of other great articles written by top-notch financial savants, check out more of, which also examines topics such as stop-payment pitfalls, post-dated checks, and why banks require you to deposit checks made out to your business instead of cashing them. By the time you're done perusing, you should have added many useful articles to your home-office library at absolutely no charge.

Kurt Samson is a freelance business writer and public relations consultant in Annapolis, Maryland.

Edition: October 2016

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