Financial statements give you a snapshot of your business, but financial ratios help you understand what that snapshot means. They’re simple formulas that give you insight into the health of your business, how well you’re managing money, and where you can improve.
Here are four important types of financial ratios to help you assess your business performance.
1. Profitability Ratios
These ratios show how well your business is generating profit. They help answer questions like: Are we making money? Are we pricing correctly?
Examples:
- Gross Profit Margin = (Revenue – Cost of Goods Sold) ÷ Revenue
Tells you how much of each dollar you keep after direct costs. - Net Profit Margin = Net Profit ÷ Revenue
Shows your overall profitability after all expenses. - Operating Profit Margin = Operating Profit ÷ Revenue
Focuses on core business operations, excluding things like taxes and interest.
Tip: Compare your ratios to industry benchmarks to see how you’re doing.
2. Liquidity Ratios
Liquidity ratios show whether your business can meet short-term financial obligations—essentially, do you have enough cash (or assets you can quickly turn into cash) to pay your bills?
Examples:
- Current Ratio = Current Assets ÷ Current Liabilities
A ratio of 1.5 or higher is typically considered healthy. - Quick Ratio = (Cash + Accounts Receivable) ÷ Current Liabilities
A more conservative view that excludes inventory.
If your ratios are too low, it could signal trouble paying suppliers or covering upcoming expenses.
3. Leverage Ratios
Leverage ratios look at how much debt your business is carrying and how easily you can manage it.
Example:
- Debt-to-Equity Ratio = Total Debt ÷ Shareholders’ Equity
A high ratio may be risky, especially if your income fluctuates.
The right level of debt depends on your industry and business model. Some businesses can operate effectively with higher debt, while others benefit from staying lean.
4. Efficiency Ratios
These ratios measure how efficiently you’re using your resources to generate revenue. They’re especially useful for identifying waste or areas for improvement.
Examples:
- Inventory Turnover = Cost of Goods Sold ÷ Average Inventory
Shows how often inventory is sold and replaced in a period. - Accounts Receivable Turnover = Revenue ÷ Average Accounts Receivable
Helps you track how quickly customers are paying you.
If your turnover is low, it may be time to revisit your payment terms or improve inventory management.
Why Financial Ratios Matter
- They give you a clearer view of your business performance beyond just dollars in and out.
- Lenders often use them to evaluate your risk level.
- Tracking them regularly helps you catch potential problems early and make informed decisions.
Need Help Interpreting the Numbers?
Business Link’s advisors can help you understand your financial statements and what the numbers mean for your business. We also offer tools and templates to help you track performance and plan for growth.