Key performance indicators (KPIs) were top of mind for finance teams surveyed for NetSuite’s Winter Outlook report. Finance teams said they’re focused on using data more effectively, producing better reports on KPIs and finding ways to save money. But executives who didn't work in finance had different priorities. One possible explanation for the rift, according to the report analysts, is that financial data needs context. It needs an accompanying narrative to illustrate the point and show the state of the business' finances. One way to simplify the data and make it more accessible for investors, lenders and internal stakeholders is using financial ratios.
What Is a Financial Ratio?
A financial ratio is a measure of the relationship between two or more components on the company’s financial statements. These ratios give you a quick and straightforward way to track performance, benchmark against those within an industry, spot trouble and proactively put solutions in place.
Why Is Measuring Financial Ratios Important?
Ratios help business leaders compare the company with competitors and more generally with those within their given industry. They enable a business to benchmark its performance and target areas for improvement. They help companies see problematic areas and put measures in place to prevent or ease potential issues. And if the business is seeking outside funding from a bank or an investor, financial ratios provide those stakeholders with the information needed to see if the business will be able to pay the money back and produce a strong return on investment.
19 Key Financial Ratios to Track
Financial ratios measure profitability, liquidity, operational efficiency and solvency.
Ratios that help determine profitability
The data used to calculate these ratios are usually on the income statement.

Gross profit margin:
Higher gross profit margins indicate the company is efficiently converting its product (or service) into profits. The cost of goods sold is the total amount to produce a product, including materials and labor. Net sales is revenue minus returns, discounts and sales allowances.
Gross profit margin = net sales – cost of goods or services sold/net sales X 100

Net profit margin:
Higher net profit margins show that the company is efficiently converting sales into profit. Look at similar companies to benchmark success as net profit margins will vary by industry.
Net profit margin = net profit/sales X 100

Operating profit margin:
Increasing operating margins can indicate better management and cost controls within a company.
Operating profit margin = gross profit – operating expenses/revenue X 100
Gross profit minus operating expenses is also known as earnings before interest and taxes (EBIT).
(Video) FINANCIAL RATIOS: How to Analyze Financial Statements 
Return on equity:
This measures the rate of return shareholders get on their investment after taxes.
Return on equity = net profit/shareholder’s equity
Ratios that measure liquidity
These metrics measure how fast a company can pay back its shortterm debts. Use information from the balance sheet and the cash flow statement for these ratios.

Working capital or current ratio:
Can the business meet shortterm obligations? A working capital ratio of 1 or higher means the business’ assets exceed the value of its liabilities. The working capital ratio is also known as the current ratio.Working capital ratio = current assets/current liabilities

Cash ratio:
This measure is similar to the working capital ratio, but only takes cash and cash equivalents into account. This will not include inventory.
Cash ratio = cash and cash equivalents/current liabilities

Quick ratio:
Similar to the cash ratio, but also takes into account assets that can be converted quickly into cash.
Quick ratio = current assets – inventory – prepaid expenses/current liabilities

Cash flow to debt ratio:
Measures how much of the business' debt could be paid with the operating cash flow. For example, if this ratio is 2, the company earns $2 for every dollar of liabilities that it can cover. Another way of looking at it is that the business can cover its liabilities twice over.
Cash flow to debt ratio = operating cash flow/debt
There are a couple ways to calculate the operating cash flow. One is to subtract operating expenses from total revenue. This is known as the direct method.
(Video) Financial Ratios And How To Use Them In Small Businesses 
Operating cash flow to net sales ratio:
Measures how much cash the business generates relative to sales. Accounting Tools says this number should stay the same as sales increase. If it’s declining, it could be a sign of cash flow problems.
Operating cash flow to net sales ratio = operating cash flow/net sales

Free cash flow to operating cash flow ratio:
Investors usually like to see high free cash flow. And a higher ratio here is a good indicator of financial health.
Free cash flow = cash from operations — capital expenditures
Free cash flow to operating cash flow ratio = free cash flow/operating cash flow
Cash equivalents are investments that mature within 90 days, such as some shortterm bonds and treasury bills.
Ratios that measure operational efficiency
These ratios point to the company’s core business activities. They’re calculated using information found on the balance sheet and income statement.

Revenue per employee:
How efficient and productive are employees? This ratio is a good way to see how efficiently a business manages its workforce and should be benchmarked against similar businesses.
Revenue per employee = annual revenue/average number of employees in the same year

Return on total assets:
Looks at the efficiency of assets in generating a profit.
Return on total assets = net income/average total assets
Calculate average total assets by adding up all assets at the end of the year plus all the assets at the end of the prior year and divide that by 2.

Inventory turnover:
Examines how efficiently the company sells inventory. Start with the average inventory by taking the inventory balance from a specific period (a quarter, for example) and add it to the prior quarter inventory balance. Divide that by two for the average inventory.
(Video) 10 key financial ratios for small businesses that'll help you make more moneyInventory turnover = cost of goods sold/average inventory

Accounts receivable turnover:
Measures how well a company is managing collections. A higher rate usually means customers are paying quickly. You’ll need to know the average accounts receivable. To calculate that, take the sum of starting and ending receivables over a period and divide by two. This period can be a month, a quarter or a year.Accounts receivable turnover = net annual credit sales/average accounts receivable.

Average collection:
This is a related measure to give a business the sense of how long it takes for customers to pay their bills. Here’s the formula to calculate the average collection period for a given year.
Average collection = 365 X accounts receivable turnover ratio/net credit sales
To calculate net credit sales, use this formula:
Net credit sales = sales on credit — sales returns — sales allowances

Days payable outstanding (DPO):
The average number of days it takes the company to make payments to creditors and suppliers. This ratio helps the business see how well it's managing cash flow. To calculate DPO, start with the average accounts payable for a given time (could be a month, quarter or year):
Average accounts payable = accounts payable balance at beginning of period — ending accounts payable balance/2
DPO = average accounts payable/cost of goods sold x number of days in the accounting period
The resulting DPO figure is the average number of days it takes for a company to pay its bills.

Days Sales Outstanding:
Shows how long on average it takes for customers to pay a company for goods and services.
Days sales outstanding = accounts receivable for a given period/total credit sales X number of days in the period
(Video) Michael R King COM371 19a Financial Ratios
Ratios that help determine solvency
These ratios look at a business’ ability to meet longterm liabilities using figures from the balance sheet.

Debt to equity ratio:
An indication of a company’s ability to repay loans.
Debt to equity ratio = total liabilities/shareholder’s equity

Debt to asset ratio:
Gives a sense of how much the company is financing its assets. A high debt to asset ratio could be a sign of financial trouble.
Debt to asset ratio = total liabilities/total assets
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How to Use Financial Ratios
These financial ratios provide easytoaccess and insightful information for potential investors and lenders. The ratios are a way for startups to show investors that the business is financially solid. The ratios related to accounts receivable are especially important for small businesses seeking loans. According to peertopeer lending marketplace Funding Circle , banks appraise eligible receivables at 70%–80% of their value for assetbacked loans.
Financial ratios are for more than just securing funding. They can be used to provide KPIs and help guide strategic decisions to meet business goals. For example, calculating inventory turnover and comparing it to industry averages helps a company strike a balance between having too much cash tied up in inventory or too little inventory on hand to meet demand.
The Federal Reserve Bank of Chicago found that there is a direct correlation between financial management and financial health of small businesses. And the more often a small business analyzes the numbers from sound financial management practices, the higher its success rate. Those that do it annually, the U.S. Small Business Administration says, have a success rate as low as 25%. Done monthly or weekly, those rates climb to 75–85% and 95% respectively. And these small business financial ratios are a way to see and track insightful information.
All of this information will come from a company’s financial statements. Using technology to automate the accounting process to create the static financial statements saves time and eliminates human error. Using small business accounting software gives you more accurate and complete financial information and makes calculating the financial ratios quicker and simpler. Understanding the context of the ratios is the important first step. But automating the processes behind the ratios gives you a clearer, more accurate and easiertounderstand picture of your company’s finances.
FAQs
What financial ratios are important for a small business? ›
 The cash flow to debt ratio. The calculation is: Net income divided by total debt = the cash flow to debt ratio. ...
 The net profit margin. ...
 Gross margin ratio. ...
 Sales per employee ratio.
 #1 Gross Profit Margin. Gross profit margin – compares gross profit to sales revenue. ...
 #2 EBITDA Margin. ...
 #3 Operating Profit Margin. ...
 #4 Net Profit Margin. ...
 #6 Return on Assets. ...
 #7 Return on Equity. ...
 #8 Return on Invested Capital.
Simply trying to memorize the equations themselves will make it difficult to remember each one as you go about trying to recall them later. Instead, write down each ratio and work each out several time using different numbers until you have a firm grasp of what each one means.
What is a ratio analysis for a small business? ›Ratio analysis is the act of using various components of financial information in order to provide a snapshot of a company's financial health. Ratio analysis is frequently used by business owners as well as investors who want better insight into the financial performance of the business in a variety of areas.
What are 5 most important ratios in financial analysis? ›The common financial ratios every business should track are 1) liquidity ratios 2) leverage ratios 3)efficiency ratio 4) profitability ratios and 5) market value ratios.
What is the most useful financial ratio? ›Return on equity ratio
This is one of the most important financial ratios for calculating profit, looking at a company's net earnings minus dividends and dividing this figure by shareholders equity. The result tells you about a company's overall profitability, and can also be referred to as return on net worth.
Key ratios are the primary financial ratios used to illustrate and summarize the current financial condition of a company. They are produced by comparing different line items from the subject's financial statements. Analysts and investors use key ratios to see how companies stack up against their peers.
What is the best way to evaluate financial ratios? ›To calculate common size ratios from your balance sheet, simply compute every asset category as a percentage of total assets, and every liability account as a percentage of total liabilities plus owners' equity. (Multiplying by 100 converts the ratio into a percentage.)
What is the best ratio to evaluate profitability? ›Consider aiming for profit ratios between 10% and 20% while paying attention to the industry's average, since most industries usually consider 10% as the average and 20% high or above average.
What are at least 3 techniques ratios that you can use to measure financial performance? › Gross Profit Margin. Gross profit margin is a profitability ratio that measures what percentage of revenue is left after subtracting the cost of goods sold. ...
 Net Profit Margin. ...
 Working Capital. ...
 Current Ratio. ...
 Quick Ratio. ...
 Leverage. ...
 DebttoEquity Ratio. ...
 Inventory Turnover.
What are the 4 most commonly used categories of financial ratios? ›
 Liquidity ratios.
 Activity ratios (also called efficiency ratios)
 Profitability ratios.
 Leverage ratios.
Learn how these five key ratios—pricetoearnings, PEG, pricetosales, pricetobook, and debttoequity—can help investors understand a stock's true value. Figuring out a stock's value can be as simple or complex as you make it.
How do small businesses use financial ratios to manage its performance? ›Financial ratios go beyond the numbers to reveal how efficiently your company is at funding itself, making a profit, growing through sales, and managing expenses. They can also provide a warning sign that things aren't working, letting business owners and managers know when to make a change.
What are considered good ratios for a company? ›A working capital ratio of 2 or higher can indicate healthy liquidity and the ability to pay shortterm liabilities. On the other hand, it could also point to a company that has too much in shortterm assets (e.g., cash), some of which could be better used to invest in the company or pay shareholder dividends.
What are the key ratios to analyze a company? › Quick ratio.
 Debt to equity ratio.
 Working capital ratio.
 Price to earnings ratio.
 Earnings per share.
 Return on equity ratio.
 Profit margin.
Financial ratios can be computed using data found in financial statements such as the balance sheet and income statement. In general, there are four categories of ratio analysis: profitability, liquidity, solvency, and valuation.
What is a good balance sheet ratio? ›Most analysts prefer would consider a ratio of 1.5 to two or higher as adequate, though how high this ratio depends upon the business in which the company operates. A higher ratio may signal that the company is accumulating cash, which may require further investigation.
What are the most important financial ratios from income statement? ›Some of the most common ratios include gross margin, profit margin, operating margin, and earnings per share. The price per earnings ratio can help investors determine how much they need to invest in order to get one dollar of that company's earnings.
What is the golden ratio for finances? ›The golden ratio budget echoes the more widely known 503020 budget that recommends spending 50% of your income on needs, 30% on wants and 20% on savings and debt. The “needs” category covers housing, food, utilities, insurance, transportation and other necessary costs of living.
What is the most important financial ratio a CFO would look at? ›Debt to Equity Ratio(D/E Ratio)
What are the five major categories of ratios? ›
 Market.
 Profitability.
 Debt.
 Activity.
 Liquidity.
 How do you calculate the payback period?
 What is financial leverage?
 What is the difference between gross margin and markup?
 What is the debt to total assets ratio?
 What is the difference between vertical analysis and horizontal analysis?
 What is a current asset?
 What is the gross margin ratio?
 Gross Profit Margin. ...
 Working Capital. ...
 Current Ratio. ...
 Inventory Turnover Ratio. ...
 Leverage. ...
 Return on Assets. ...
 Return on Equity.
The main use of ratio analysis is to compare the strengths and weaknesses of each firm. The ratios can also be compared to the firm's previous ratio and help analyze whether the company has progressed.
What are the three main profitability ratios? ›The following types of profitability ratios are discussed for the students of Class 12 Accountancy as per the new syllabus prescribed by CBSE: Gross Profit Ratio. Operating Ratio. Operating Profit Ratio.
What are the two most commonly used profitability ratios? ›Two of the most common return ratios that businesses calculate are return on assets (ROA) and return on equity (ROE). Your company's return on assets, also called return on investment, is all about efficiency. It indicates how good your company is at turning its investments into a profit.
What is a good efficiency ratio? ›An efficiency ratio of 50% or under is considered optimal. If the efficiency ratio increases, it means a bank's expenses are increasing or its revenues are decreasing.
What financial measures are the most important indicator of business performance? ›Two best metrics to measure the financial performance of a company in terms of profitability are the net profit and the return on assets. The percentage of net profit is the amount of net profit divided by the amount of sales times 100.
What are the three most commonly practiced methods of financial analysis? ›Several techniques are commonly used as part of financial statement analysis. Three of the most important techniques are horizontal analysis, vertical analysis, and ratio analysis.
What are the three 3 common types of ratios analysis? › Liquidity Ratios. Liquidity ratios can help you measure a company's ability to handle its shortterm debt obligations. ...
 Profitability Ratios. This ratio helps measure a company's ability to earn sufficient profits. ...
 Solvency Ratios. ...
 Turnover Ratios.
What is the rule of thumb for financial ratios? ›
A general rule of thumb is to have a current ratio of 2.0. Although this will vary by business and industry, a number above two may indicate a poor use of capital. A current ratio under two may indicate an inability to pay current financial obligations with a measure of safety.
What is the rule of thumb for current ratio? ›By rule of thumb, if a company's current ratio is above 1.00, it has sufficient current assets to cover its current liabilities. If a company's current ratio is 1.50 or above, it has ample working capital to cover all current liabilities.
What are the types of ratios most commonly used in financial analysis? ›Ratio Analysis is done to analyze the Company's financial and trend of the company's results over years where there are mainly five broad categories of ratios like liquidity ratios, solvency ratios, profitability ratios, efficiency ratio, coverage ratio which indicates the company's performance and various examples of ...
What are the 7 basic common stock categories? › Income Stocks. An income stock is an equity security that offer high yield that may generate from the majority of security's overall returns. ...
 Penny Stocks. ...
 Speculative Stocks. ...
 Growth Stocks. ...
 Cyclical Stocks. ...
 Value Stocks. ...
 Defensive Stocks.
A 70/30 portfolio signifies that within your investments, 70 percent are allocated to stocks, with the remaining 30 percent invested in fixedincome instruments like bonds.
What are the 4 techniques ratios that you can use to measure financial performance? › Uses and Users of Financial Ratio Analysis. ...
 Current ratio = Current assets / Current liabilities. ...
 Acidtest ratio = Current assets – Inventories / Current liabilities. ...
 Cash ratio = Cash and Cash equivalents / Current Liabilities. ...
 Operating cash flow ratio = Operating cash flow / Current liabilities.
 Common Size Ratio = Line Item / Total.
 Current Ratio = Total Current Assets to Total Current Liabilities.
 Quick Ratio = (Total Current Assets – Total Current Inventory) / Total Current Liabilities.
 Inventory Turnover Ratio = Cost of Goods Sold / Average Inventory.
The optimal debttoequity ratio will tend to vary widely by industry, but the general consensus is that it should not be above a level of 2.0. While some very large companies in fixed assetheavy industries (such as mining or manufacturing) may have ratios higher than 2, these are the exception rather than the rule.
How do you evaluate company performance with ratios? › Current ratio  current assets divided by current liabilities. ...
 Quick or acidtest ratio  current assets (excluding stock) divided by current liabilities. ...
 Defensive interval  liquid assets divided by daily operating expenses.
 Liquidity ratios.
 Activity ratios (also called efficiency ratios)
 Profitability ratios.
 Leverage ratios.
What financial ratios are important for startups? ›
 Burn rate. From the moment your Startup launches, you are on a timer known as burn rate. ...
 Cash runway. The second of the most important accounting ratios for startups, is the cash runway. ...
 Cost of goods sold (COGS) ...
 Average revenue per user (ARPU) ...
 Monthly recurring revenue (MRR)
There are six basic ratios that are often used to pick stocks for investment portfolios. These include the working capital ratio, the quick ratio, earnings per share (EPS), priceearnings (P/E), debttoequity, and return on equity (ROE).
What are the most important ratios to look for in a company? › Quick ratio.
 Debt to equity ratio.
 Working capital ratio.
 Price to earnings ratio.
 Earnings per share.
 Return on equity ratio.
 Profit margin.
Financial ratio analysis is often broken into six different types: profitability, solvency, liquidity, turnover, coverage, and market prospects ratios.
Where can I find financial ratios for a company? › D&B Key Business Ratios. D&B Key Business Ratios (KBR), provided by Mergent, provides immediate online access to recent competitive industry benchmarking data for public and private companies. ...
 Mergent Online. ...
 S&P Capital IQ NetAdvantage. ...
 Value Line Research Center  6 user limit.
Objectives of Ratio Analysis are:
Simplify accounting information. Determine liquidity or Shortterm solvency and Longterm solvency. Shortterm solvency is the ability of the enterprise to meet its shortterm financial obligations.
The profitability ratios often considered most important for a business are gross margin, operating margin, and net profit margin.
How do you evaluate financial performance of a startup? › Runway. Runway (a.k.a cash runway) is how many months your startup has before it runs out of cash. ...
 Burn Rate. Burn rate is heavily related to runway. ...
 Revenue. ...
 MRR. ...
 Average Revenue Per Account. ...
 MRR Churn. ...
 Customer Lifetime Value. ...
 CAC.
The five key documents include your profit and loss statement, balance sheet, cashflow statement, tax return, and aging reports.
What is the best ratio to measure company performance? ›Total Asset Turnover
Total asset turnover is an efficiency ratio that measures how efficiently a company uses its assets to generate revenue. The higher the turnover ratio, the better the performance of the company.
Which ratio is best to use to compare two companies? ›
PricetoEarnings Ratio (P/E)
The P/E ratio gives an investor an easy way to compare one company's earnings with those of other companies.