How healthy is your business? Many businesses just look at their profit & loss statement (aka income statement), but you could be missing out on some helpful information.
Have you ever heard of accounting ratios? The first time I even learned of them was when I somehow stumbled on them in the help in QuickBooks (it’s no longer in there). But they explained why I was struggling financially even though I had money in my bank account and my P & L showed a profit.
Banks often use ratios to analyze your financial statements as part of the loan approval process, so it’s helpful to know in advance what they’ll see. Acceptable ratios can vary by industry, so you might find that your accountant or trade association may have those numbers. Would let you know how you compare to those in the same line of work.
Profit margin is a simple one. This looks at the percentage of sales you get to keep before taxes. Acceptable margins vary widely by industry. An easy way to get this percentage is to
- Run your P & L.
- Click on Customize Report
- Click on Percent of Income
- Now you have your percentage. In this example it would be 14%.
For those of you who have direct costs, like contractors, landscapers, wholesalers, retailers, you may also want to look at your Gross Profit Margin. This looks at the percentage of sales you get to keep after your direct expenses but before your overhead. So, if you have your direct expenses showing as Cost of Goods Sold (which I highly recommend), then this is just as simple at the Profit Margin ratio. Using the steps listed for profit margin ratio, you can now see the percentage of direct expenses before overhead. In our example, Quality Built Construction has a 43% Gross Profit Margin.
Now here are a couple of the ratios I stumbled upon. To calculate these ratios means you need to run your Balance Sheet (I know many of you do not), and that the Balance Sheet is in good shape. (I run it at client sites to see if they are making common mistakes that can go unseen on the P & L but jump out at you on the Balance Sheet). But that’s an article for another day.
Current Ratio – How easily can you pay your debts? For a true picture, you will want to include the “current portion of long-term debt”. In other words, if you have 4 years left on a loan, move 12 months of principle from long-term liability to current liability. (Your accountant or lending institution could help you determine this number if you need assistance.) This can be a substantial dollar amount depending on the number and size of your loans. But even if you don’t do this, it can still be a good eye opener. Simply divide your Total Current Assets by your Total Current Liabilities. In this example, you would take 302,185 divided by 54,690.
Debt Ratio – What percentage of your business is financed by debt? To get this ratio, divide Total Liabilities (debt) by Total Assets. For Quality Built Construction, you would take 68,675 divided by 374,142.
So take a look at these ratios for your business and see what you get. If you want to know if they are good or bad, your accountant can help you determine how you are doing for your industry. I would recommend that you look at these at least quarterly if not monthly. You may find that for your industry, these ratios will fluctuate seasonally.
And, if you’re not sure if your balance sheet is in good shape, your accountant can give you a quick yes or no – hopefully you’ll get a yes. If it’s no, we’ll be happy to see what may be going wrong in your QuickBooks.