Two Essential Business Ratios

Posted by: Rod Kurtz on July 29, 2009

There are key business ratios that you should use to measure your strengths, weaknesses, and overall success. Using these ratios periodically can help identify and correct weaknesses while building upon your company’s strengths. To get you started, here are two of the most important questions to answers/ratios to use to do so:
1. Is the company earning a profit? The gross profit margin equals gross profit divided by revenue. This will give you a measure of the gross profit percentage per dollar of sales.

2. Is the company solvent? The current ratio equals the current assets divided by current liabilities. This will give you a measure of the company’s ability to pay short term debts. A current ratio of assets to liabilities of less than 2 to 1 is frequently considered unsatisfactory, and will show you where your business needs to improve.

Stephen C. Erickson
Partner
SageCreek Partners
Alpine, UT

Reader Comments

Ken Kaufman

August 6, 2009 4:32 AM

While these two ratios are very important, they can be looked at individually or out of context with all of the other key metrics in the firm. For example, a company could show a great gross profit and a current ratio of 2 or better but still be headed quickly to disaster. How? f sales volume is not at or above break even, then the company is headed in the wrong direction quickly.

How could this happen? If equity was just infused into the company and it is sitting in cash, it gives a false sense of liquidity. Lower volume usually does not impact your gross profit because most of the direct costs are variable. So, these two ratios could look great, but the company could still be in big trouble in the very near future.

There are two critical elements needed when deciding on the key metrics a business should "dashboard." First, you have to know what the averages and benchmarks are for your industry. Second, you should know what your averages and benchmarks are for your company as well. And third, you have to develop what many call a balanced scorecard that looks at the whole picture of the company, not just one silo-ed part.

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