Financial Ratios Every Business Owner Should Know

Running a small business isn’t just about selling products or services—it’s about making smart decisions backed by data. Financial ratios give you a snapshot of your business’s health and help you manage cash flow, monitor profitability, and plan for growth. In this post, we’ll cover some of the most important ratios small businesses should track and what they mean.

1. Current Ratio

Current Assets ÷ Current Liabilities

Purpose: This ratio measures your business’s ability to meet short-term obligations. It tells you whether you can cover your bills due in the short term using assets like cash, receivables, and inventory.

What it means: A ratio between 1.5 and 2 is generally healthy. A ratio below 1 indicates liquidity issues—your liabilities exceed your assets, which can lead to cash flow problems.

2. Quick Ratio (Acid-Test Ratio)

(Current Assets - Inventory) ÷ Current Liabilities

Purpose: This is a stricter version of the current ratio. It excludes inventory, which may not be easily converted to cash, offering a more conservative measure of liquidity.

What it means: A ratio of 1 or above shows you can meet obligations with liquid assets. Below 1 may mean you’re too reliant on inventory or facing a cash crunch.

3. Gross Profit Margin

(Gross Profit ÷ Revenue) × 100

Purpose: This ratio shows how efficiently your business produces goods or services. It indicates how much of your revenue is left after covering the cost of goods sold (COGS).

What it means: Margins vary by industry, but 50% or more is excellent for service businesses; 20–40% is common for retail. Falling margins suggest rising costs or price pressures. Watch for shrinking profits even when sales are increasing.

4. Net Profit Margin

(Net Profit ÷ Revenue) × 100

Purpose: This ratio reveals how much profit you keep from each dollar of revenue after all expenses (including taxes and interest).

What it means: A consistent, positive margin means your business is operating efficiently. 10% or more is solid for many small businesses. Low or negative margins mean expenses are eating into profits. Time to review your cost structure and pricing.

5. Accounts Receivable Turnover

Net Credit Sales ÷ Average Accounts Receivable

Average Accounts Receivable = (Opening Balance + Closing Balance) ÷ 2

Purpose: This ratio shows how quickly you collect money from customers. A higher ratio means faster collections and better cash flow.

What it means: A ratio of 8–12 per year suggests you collect every 30–45 days. That’s healthy for most industries. Lower turnover means you’re taking too long to collect payments, which can cripple your cash flow.

6. Inventory Turnover

COGS ÷ Average Inventory

Purpose: It measures how many times you sell and replace your inventory over a period. Helps identify overstocking or understocking issues.

What it means: A ratio of 5–10 per year is common depending on the industry. Faster turnover means efficient inventory management. Low turnover suggests overstocking or slow-moving items. High turnover may indicate stockouts or lost sales.

7. Debt-to-Equity Ratio

Total Liabilities ÷ Shareholders’ Equity

Purpose: This ratio measures financial leverage—how much you rely on debt.

What it means: A ratio below 1 is usually preferred. It shows you’re not over-leveraged and have more equity than debt. A ratio above 2 can indicate high risk, especially in a downturn.

8. Return on Assets (ROA)

Net Income ÷ Total Assets

Purpose: ROA tells you how efficiently your business uses its assets to generate profit.

What it means: A ROA of 5–10% or higher is good for small businesses. Low ROA can signal underutilized assets or weak profitability.

How to Use These Ratios Effectively

· Benchmark by industry: Compare your ratios to industry averages.

· Monitor trends: Don’t rely on a single data point—track ratios over time.

· Integrate with decision-making: Use ratios to guide pricing, investment, staffing, and financing decisions.

· Use software tools: Most accounting platforms like QuickBooks, Xero, or Wave generate these ratios

automatically. Pair them with dashboards for quick insights.

Final Thoughts

Financial ratios are essential tools for every small business owner. Understanding them empowers you to spot issues early, optimize operations, and make informed decisions.

Need Help Understanding Your Numbers?

If you’re feeling unsure about how your business is performing—or want expert help setting up, analyzing, or discussing your financial ratios, KPIs, cash flow projections, or budgets—we’re here for you.