Do you know how healthy is a business? 
Here are two examples of a first year business:
Business A: You have proudly made profit! But you are shocked to see the balance in your bank account. Why is it so low?
Business B: $$$ in the bank account but why did my business record a loss?
How is that possible?
How do I know if my business is healthy and what should I do?
The bottom line is that “Profit or Loss” should not be the ONLY thing you look at
Just like your body, weight alone does not determine if you are healthy or not.
There are other financial KPIs which portray a clearer picture of your business performance.
Now let’s talk about some of the few important KPIs available and what insight does it provide to the business.
1. Current Ratio
Current ratio measures the solvency of the company which shows a company’s ability to pay off short-term debts.
Formula: Current Assets /Current Liabilities
Current assets = cash, receivables, inventory, short term investments
Current liabilities = payable, short term loans
A healthy benchmark will be between 1.5:1 to 3:1.
2. Quick Ratio
Quick ratio is able to tell if the business has enough readily available funds to cover short term obligations.
Quick ratio measures immediate liquidity while current ratio measures liquidity within a year.
Formula: (Current Assets – Inventory)/Current Liabilities
A healthy benchmark will be generally at 1:1.
3. Debt Ratio
Debt ratio shows the level of leverage and can be used to assess how much risk a company has acquired.
It provides a view on if the company is financed primarily by debt, equity or a combination of both.
A business should keep the debt ratio at a optimal level and use its debt wisely to expand the business. A low ratio may indicate that the business is not expanding. A high ratio may indicate that the business is heavily in debt.
Formula: Total debt/Total assets
4. Trade Receivables Turnover Days
Trade receivables turnover days tell you how quickly your business is collecting cash from sales. The lower it is the better as it means customers are paying promptly.
There are no standard turnover days as it varies from industry to industry. However, you can always use the credit term given to customer as a benchmark and also compare the turnover days over the years.
Generally, a Business to Consumer industry typically have lower turnover days than a Business to Business industry.
Formula: Average receivables/ Yearly sales x 365 days
5. Inventories Turnover Days
Inventories turnover days tells you how quickly your business is selling its inventories. High ratio may indicate excessive stock or slow sales. Low ratio may indicate low stock balance or strong sales.
Turnover can be calculated on specific inventory item to identify which stocks are better selling which in turn aids with better inventory management such as changing marketing strategy or bundling up slow moving goods with fast moving goods to clear off excessive inventory.
Formula: Average inventory/ Cost of goods sold x 365 days
6. Gross Profit Margin
Gross profit margin measures the profitability of the business in providing its sales and services before taking into account its operating expenses.
A business should aim to improve its gross margin by increasing revenue while decrease its cost of goods sold.
Formula: Gross Profit/Revenue
With the above background, let’s refer to the example given.
Business A may have a high receivables turnover days which means the business is not collecting its cash quick enough. Hence, the low balance in the bank.
Business B may have a low profit margin but high debt ratio which means that the business is not efficiently utilising its debt to convert to revenue.
Are you having the same questions as the business owners?
Well its time to look beyond profit and into the financial KPIs.
We can assist by providing insight into the business’s financial information with our interactive financial data analysis.
Contact us today to find out more.
All information, materials, content and/or advice in this article is for informational purposes only and is not intended to replace or substitute for any professional advice.
