Is your business thriving? Calculate these key metrics to find out...

Jun 8, 2024

3 min read

Financial Ratios! These essential measurements reveal your business' financial health.

Gross profit margin : Ability to control direct expenses, higher is better
Net profit Margin : Depends on type of industry, company’s pricing policy, sales volume and cost structure. Higher is better. Too high, maybe overpriced, decrease in quantity sold"
Return on capital employed : Indicator of management efficiency, how well utilised total assets. Higher is better. Factors impacting : asset valuation process; depreciation, revaluation and pricing policies; treatment of expenses"

Asset turnover : Measures the amount of sales generated by the capital employed or total assets investment. If change is lower than prior year, there is an Over-investment, Assets are new or company policy that prefers to purchase rather than lease/rent. If extremely high, products have a high selling price
Fixed Assets Turnover : Measures how effectively the firm uses its plant and equipment to generate sales. Higher means a greater recovery of investment in plant, property and equipment. If lower than competitors means over-investment in non-current assets. Consider : Depreciation rate, Purchase instead of lease, Relatively new assets
Inventory turnover days : Measure efficiency at maintaining an appropriate level of inventory and indicates liquidity. If lower means low inventory level, greater efficiency, or inventory is running out often and not meeting demand. If higher, Business may be slowing down; Lower efficiency, stocks piling, may have obsolete stocks that could lead to liquidity crisis; Higher inventory volumes due to purchasing in bulk to obtain discounts. Compute average of opening and closing inventory to eliminate seasonal effects.

Current Ratio : Sufficiency of short term assets to meet short term liability, higher is better. If ratio exceeds normal range could mean A build up of inventory to support a recent advertising campaign; Permanent expansion of business which require continuing higher level of inventories; Inefficient control over working capital; Adverse trading condition e.g. over trading.
Acid test / Quick ratio : Inventory difficult to convert to cash at short span of time so is excluded. Higher is Better.
Trade Receivable days : Indicates efficiency of company at controlling its collection of receivables. Compare with industry norm & company’s credit policy, closer is better. If reduced, Successful in reducing bad debts & eliminating poor risks. Extending discounts & incentives can encourage early payment. If Increased, Poor credit control and besieged with bad debts; May be strategy to attract new customers.
Trade Payables days : Indicates credit period extended to a company by its supplier. Closer is better. If payables days change, Suppliers altering credit terms (more/less generous). Increase means company trying to gain maximum credit facilities. If decrease, company utilising early payment incentives.

Dividend yield : Measure real rate of return by comparing dividend paid to the market price.
Earnings per share : The earning power of each ordinary share, Higher is better
Dividend cover : Proportion profit distributed to ordinary shareholders, Higher means maintained ordinary dividends level
Price earnings (P/E) ratio : Shows how market assesses performance of a company (measure of market confidence). Checks if shares are over/under priced, overpriced if higher than industry norm. If higher : Market thinks that company’s future is good; Shares are in demand, hence the high share price

Debt ratio : Measures whether the company has sufficient assets to meet all its liabilities when due, lower is better
Capital gearing ratio and Debt to equity : Higher means predominantly financed by debt and Lower is better as it relies on equity finance
Interest cover : Indicates whether enough profit is earned to pay interest (security of interest payments).