Understanding Financial Ratios for a Small Business

Understanding Financial Ratios For A Small Business
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Understanding Financial Ratios for a Small Business
Small business analyzes the health of their business using several financial ratios to keep an eye on the company's growth. Several ratios test can be used to measure a company’s financial status. This paper will discuss some of the financial ratio small business can use to measure its health. It is important for small business to measure the current ratio by analyzing the liquidity of the company to understand if the company can pay its debts with a short period after analyzing the cash flow, inventory, and receivables. To get the current ratio, you divide is the current assets and current liabilities (Lussier & Corman, 2015).
On the other hand, quick ratio is used to measure the current liquid assets that can cover the current liabilities. The quick ratio can be measured by adding cash, equivalents, marketable investment, and account receivable then dividing the sum by the current liabilities (Gitman, Juchau & Flanagan, 2015). The current ratio helps us reflect on the company's financial strength by knowing if the current business assets exceed its current liabilities (Gitman, Juchau & Flanagan, 2015). The quick ratio is more of an acid test because it focuses on liquid assets as compared to the current liabilities, it enables the business to be aware if it can meet its obligation even when the adverse condition occurs(Lussier & Corman, 2015).
The debt ratio is also import for small business because it measures the debts of the company comparing it to the owner's equity. It shows the debt status of the company . To calculate the debt ratio we divide the total liabilities by the net worth (Gitman, Juchau & Flanagan, 2015). In a situation where the debt ratio is greater than one, it means that the capital by the lender is more than the capital of the owner. In such cases, the company with a high debt ratio is at a greater risk (Gitman, Juchau & Flanagan, 2015).
Time interest turnover ratio is a ratio used to measure the impartial amount of income that can enable the company cover for its expenses in future. Time interest ratio is more of a solvency ratio because it enables the company to know if it can acquire interest to service its debts. These interests are on long-term basis that is more of an ongoing expense (Gitman, Juchau & Flanagan, 2015). Small business can use the inventory turnover ratio to be aware of the inventory status by understanding the number of times it was converted to sales during a specific period(Lussier & Corman, 2015).
In most cases, small business with perishable inventory like grocery is likely to have a high inventory turnover ratio compared to furniture stores with low inventory turnover ratio (Lussier & Corman, 2015). To calculate the inventory turnover ratio, we calculate the cost of goods sold by dividing it with the total inventory (Gitman, Juchau & Flanagan, 2015). In any business, it is important to be aware of the average collection period to show the average number of days for the business to have receivable cash. Having higher accounts receivable can be a liability (Lussier &...