As a business unit manager or business owner, keeping any eye on the financial health of your business is absolutely crucial.
But…
…if your background isn’t in finance, this can be a confusing task.
What do you need to look at? What are the key measurements that show you how well (or bad) your business is doing?
In business, there are FOUR types of financial ratios used to analyse the financial performance of a business (or unit):
- Profitability Ratios
- Working Capital Ratios
- Liquidity Ratios
- Gearing Ratios
Below, I’m going to give you the top three ratios you should know:
Return of Capital Employed (ROCE)
The top Profitability Ratio you need to know is: Return on Capital Employed (ROCE).
ROCE is a strategic financial performance measure and is arguably the most important ratio in determining how successful a business is performing.
ROCE is calculated by:
ROCE (%) = Operating Profit / Capital Employed x 100
Where Capital Employed is Total Equity + Long Term Debt.
Debtor Turnover
Next is the Working Capital Ratio, Debtor Turnover.
Debtor Turnover measures how long, on average, your customers are taking to settle their accounts (pay you).
Debtor Turnover is calculated by:
Debtor Turnover = Trade Receivables / Turnover x 100.
Debtor Turnover is measured in number of days.
So, the lower the Debtor Turnover (or the quicker your customers pay you), the better you are doing.
Current Ratio
Finally, the Current Ratio. The Current Ratio is a Liquidity Ratio type which shows you your business’ ability to meet your short term obligations.
Current Ratio = Current Assets / Current Liabilities.
*Current Ratio is measured as a relationship to 1.
The larger your Current Ratio, the better position or health your business is in.
I hope you found this useful to you when it comes to looking at the financial health of your business. Feel free to share this with anyone else you know who might find this useful!
