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Improve Profitability: Your Guide to Key Performance Ratios

October 25, 2016

Steve Albart, Enterprise Bank & Trust

Do you have a dashboard of performance ratios to help manage your business? Are these the same ratios your bank and bonding company analyze to make decisions about your company credit?

As a banker, I come across business owners who use one of the following types of performance dashboards. What type of owner are you?

1. Business owners who manage the business in their head and do not have any kind of specific performance dashboard.

2. Business owners who have a dashboard of information but the only person who can interpret the information is the business owner.

3. Business owners who have a dashboard of key ratios that are aligned with the bank, bonding company, industry comparisons and unique ratios for their specific business.

Why Businesses Need Dashboards

I encourage all business owners to please take the time to establish a dashboard of key performance ratios; it will help you run your business and align with key stakeholders in the business. As you can imagine, the owners who follow option #3 from above are typically the high performing companies in their markets.

Use performance ratios to:

  • Increase profitability
  • Increase business valuations
  • Access higher credit limits with better terms
  • Access more bonding capacity

The ratio analysis gives business owners information to compare the company's performance to prior periods: Year over year or quarter over quarter. Even more importantly, it helps you compare your business to others in the industry.

Guide to Useful Ratios

Here are a few ratios that can help you manage your business and obtain more credit at better terms.

Liquidity Ratios

Measures a company's ability to pay its short term debts and operating expenses. Generally, the higher the value of the ratio the larger the margin of safety the company has to meet short term operating obligations.

Current Ratio = Equals Current Assets / Current Liabilities

Compares current assets to current liabilities.

Quick Ratio = Cash and Accounts Receivable / Current Liabilities

Indicates a company’s short-term liquidity.

Solvency Ratios

Shows what percentage of assets belongs to outside creditors and what percentage belongs to owners of the business (owner’s equity). A low ratio is good because it means the company has low leverage and the owner has a lot of equity in the business.

Debt to Net Worth = Equals Total Liabilities / Net Worth

Measures a company's financial leverage

Profitability Ratios

Determines a company’s gross profit margin (operating profit) and overhead analysis. These two ratios are great ratios to perform industry analysis and period over period analysis.

Gross Profit Ratio = (Sales minus Cost of Goods) / Sales

Shows percentage of sales that exceed the cost of goods sold.

SG&A (Overhead) Ratio = SG&A / Sales

Shows percentage of selling, general and administrative costs to sales.

Profit Margin = Net Income / Sales

Shows how much profit comes from every dollar of sales.

Management or Cash Flow Ratios

Helps a company understand cash position, cash flow and management of the company.

Working Capital = Current Assets - Current Liabilities

Represents a company's captial used for its day-to-day operations.

AR Turnover = Sales / ARs

Measures how efficiently a company uses its assets.

AP Turnover = Cost of Goods / APs

Shows how quickly a company pays off its suppliers.

Inventory Turnover = Cost of Goods / Inventory

Compares a company’s inventory on hand to the amount sold.

Debt Coverage Ratio = Earnings + Interest Expense + Taxes + Depreciation + Amortization (EBITDA or Cash Flow) / Total Principal and Interest Payments on all Debts.

What Performance Ratios are Best for your Business?

The above ratios are a good start to create a dashboard; they can help you manage your company to high performance. Your banker, CPA and trade associations can help you with additional ratios and industry analyses to fine tune your dashboard.

Start with a spreadsheet and build from there. Once you have a template in place it becomes easier to manage on a monthly basis. Please keep in mind, the higher the performance of your company the more access to capital and bonding capacity you will have, allowing your business to grow.

Enterprise Bank & Trust does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only. You should consult your own tax, legal, and accounting advisers before engaging in any transaction.


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