When you think about financial ratios to monitor in your business, what comes to mind?
Here are five ratios that will help you get started, so let’s jump into it.
The following ratios will help you monitor your business’s profitability, the effectiveness of your marketing campaigns, the efficiency of your employees, and the time in which you can turn over inventory.
If you want to start measuring these ratios more closely, then read further. These will be useful no matter your experience level. We trust them, and we think that you should, too.
1. Gross Margin
Your gross margin is the money that you earn over the cost of your product. The gross margin determines how much money you have to pay for your operating expenses. Your gross margin is calculated by:
Gross Margin Ratio = (Sales – Cost of Goods Sold)/Sales
This ratio is especially useful because it can become as granular as you need it to be. Use this margin to calculate the profitability of each item you sell individually or the profitability of your business as a whole.
Overall, this ratio is essential for assessing the feasibility of different aspects of your business.
2. Cost of Acquisition
The cost of acquisition deals with two factors: the acquisition of new customers and the acquisition of assets. However, the second definition is less relevant to most businesses (at least with recurring analytics). So, we’ll focus on the cost of acquiring a customer.
You can calculate the cost of acquisition ratio for advertising by using:
Cost of Acquisition = Marketing Expenses per a given period (including marketing salaries and advertising costs) / The number of new customers in that period
Just be aware that, while useful, the cost of acquisition can often be misleading. When calculating this metric, solve for several different timeframes to get a more realistic and holistic result.
3. Stock Turnover
Stock turnover, or inventory turnover, measures the time a company takes to sell and replace its inventory during a given period. This ratio is a fantastic metric because it helps companies analyze the demand for any given product.
You can calculate stock turnover by:
Stock Turnover = Sales/((Beginning Inventory + Ending Inventory)/2)
High inventory turnover means a business constantly purchases new inventory to fulfil the demand.
4. Operating Cash Flow Ratio
This ratio helps a business calculate its liquidity in the short term. In other words, it measures a company’s ability to cover its liabilities using its regular cash flows.
You can calculate operating cash flow by:
Operating cash flow ratio = Operating cash flow/Current liabilities
This calculation method is a great measure of a business’s profitability. Simply put, cash flow is more challenging to manipulate than a net income measurement.
5. Sales Per Employee
This metric helps determine how well your employees are contributing to your bottom line.
You can calculate sales per employee by:
Sales Per Employee = Sales/Number of employees
Use this metric periodically as your business grows to measure how well your employees and your business model can adapt.
If the ratio is high, then double down on what you’re already doing. If your sales per employee ratios are low, then it may be time to either invest in more training, change up your culture, or cut back on your workforce.
These Are the Five Excellent Financial Ratios to Monitor in Your Business
Measuring simple ratios like the ones above is an easy enough task, and the insights you’ll gain will be invaluable to your company.
There are other financial ratios to monitor in your business that will lead to additional insights. However, these ratios are a good place to start.
To learn more about business finances, contact us.