Financial Ratios

The following article is an excerpt from our June 2017 newsletter:

Every rand that you spend on your business should deliver returns so that you can grow your business, pay your employees and still make a profit.  Financial ratios are calculations based on the information provided in your financial statements which enable you to objectively measure the performance of your business.

Financial ratios can be used to:

  • evaluate profitability, efficiency and risk
  • assess liquidity
  • assess overall financial position (solvency)
  • determine capacity for growth
  • drive performance through informed business decisions
  • identify symptoms of underlying problems in a business

Financial ratios can also be used to compare the performance of your business against that of your competitors using industry benchmarks.

Here are just a few useful ratios:

Current ratio: Current assets / Current liabilities: indicates the surplus liquid funds that are available in your business, the higher the value the better

Quick ratio or acid test ratio: (Current assets – Inventory)/ Current Liabilities: shows the ability of your business to pay current liabilities out of assets which are either cash or quickly convertible into cash, the higher the value the better

Accounts receivable days: Accounts receivable x 365 / Yearly turnover: shows the average number of days it takes customers to pay their accounts, an increasing value indicates an inefficiency in collecting outstanding debt

Accounts payable days: Accounts payable x 365 / Yearly cost of sales: shows the average number of days it takes to pay suppliers, an increasing value indicates that it is taking longer to pay suppliers

Inventory days: Inventory x 365 / Yearly cost of sales: shows on average how many days an item is held in inventory prior to being sold, an increasing value suggests inefficient purchasing and / or too high inventory holding

Gross profit margin: Turnover – Cost of sales = Gross profit / Turnover: measures how efficiently a business uses its materials and labour to produce and sell products profitably

Should you require any further information about using financial ratios in your business, please contact our offices.

Visit our Newsletters page for more useful information.

Comments are closed.