Business Ratios to Analyze Financial Health

By Ben Youn
Copyright 2014 Quantum Business House
WELCOME to QUANTUM BUSINESS HOUSE

 2 hours for each session
 10 minutes tea time
 Bathroom & Kitchen
 Today’s Speaker
 Please network each other
 Future Plan
- Business Forum
- Networking Events
- Business Mentoring

1. Setting up business structure (June 04)
2. Buying a business (June 11)
3. Business Planning (June 18)
4. Marketing (June 25)
5. Raising Finance (July 02)
6. Financial Management (July 09)
7. Tax system and compliance issues (July 16)
8. Risk management (July 23)
9. Financial Health Check (July 30)
10. Business Evaluation (August 06)

 a process reviewing your business in general,
and this includes inside and outside of the
business. The general symptoms to look for
are:
 Customer / Supplier relationship
 Internal checks including staff performance
level, financials and policies
 Whole business direction

 Customer requests and orders get misplaced or
not following through
 Quotes and invoices contain errors or are not
sent out
 The word ‘sorry’ becomes a common part of the
conversations with customers and suppliers
 Invoices are not paid on time
 Requests for credit references are rejected
 Limited credit purchase or shortened credit terms
 Reduction in the amount of contact you are
receiving from customers and suppliers

 Employee job satisfaction is low with
increased sick-leave, late arrivals and early
departure
 Finger pointing culture
 High staff turnover
 Tight cashflow
 Lower profitability in unit level and whole
business level

 What the business actually is vs. what you
hoped it would be
 Short term and long term future of the
business
 Understanding the economic and competitive
environment

 Rather than scratch the itch, take the time to
understand why it is there.
 Customer feedback and assessment about price,
product / service range, service levels,
communication and relationship management.
 Take action on their (customer’s point of view) –
customer value oriented.
 The principle that the organisation and every position
in it exists because what is required to be done takes
more than one person to do it – organisational
change.

 Vitally important esp. difficult times.
 Regular check of financial position.
 Is my business viable?
 Can we maintain our businesses for future
growth?
 15 Core Ratios
 Have a good accountant as your business
doctor

 Collection of debts on time (discuss with
debtors in early stage if you believe they are
in risky position)
 Maximise terms with major suppliers
 Minimise stock level (Just In Time)
 Sell Not-Really-Necessary Assets to secure
some cash inflow.
 Regular cashflow forecasting for both short-
term and long term
 Have a chat with your bankers for a loan if
necessary

 CFF provides information on future cash
resources and how the cash will be applied to
the business.
 integral part of business planning that
indicates additional funding requirements in
advance so the business owners and
managers can be prepared.

 Working capital to total sales
 Total current assets less total current
liabilities / Total sales
 indicates how much working capital per dollar
of sales the business should be maintaining.
The right percentage of the working capital
per sales dollars vary business by business
depending on the item price and inventory
turnover level

 Current Ratio
 Total Current Assets / Total Current
Liabilities
 measures whether the business holds enough
current assets to meet the debts level with a
margin of safety, and the acceptable ratio is
2:1 generally though it varies depends on the
industry.

 Leverage (gearing) ratio
 Total Liabilities / Total Equity × 100
 the level of debt financing against equity to
fund the assets of the business. Generally,
the higher the ratio, the more difficult to get
further finance.

 A profitable business is a successful
business.
 Prepare regular financial statement to check
your performance (what can be measured is
more likely to be achieved).
 Focus sales with highest sales margin.
 Don’t discount unless you can achieve the
same or better gross profit through increased
volume.
 Control costs.
 Be flexible with your staffing.

 Gross Profit Margin
 Gross Profit / Net Sales * 100
 The percentage of sales dollars remaining to
pay overhead expenses after deducting cost
of sales (Cost of Goods Sold).
 This analysis will assist you assessing the
efficiency of pricing, stock purchasing
procedures and handling as well managed

 Mark-Up
 Gross Profit / Cost of Sales * 100
 The percentage difference between the actual
cost and the selling price. It is to ensure the
business sells the products covering all the
costs incurred with the sales

 EBIT Margin
 Net profit before interest and tax / Net Sales *
100
 EBIT stands for Earnings Before Interest and Tax,
and this measure can be useful when comparing
against industry benchmark figures.
 Interest and tax are excluded when comparing
against benchmark as each business has
different figures regardless of their business
performance.

 Net Profit Margin
 Net Profit / Total Income * 100
 Unlike EBIT margin, net profit margin includes
interest and tax. This is useful figure when
comparing with different periods within the
business.

 Break-Even Analysis
 Overhead Expenses / 1- (cost of goods sold
÷ net sales)
 How many sales dollars achieved before all
the expenses are covered and actual profit
begins
 Useful to set sales targets for the business or
for sales employees.

 A business must ensure that it is efficiently
utilising and controlling its assets and
liabilities. The measures below can be used
for this purpose.

 Inventory Turnover
 Cost of Goods Sold / Average stock held for
the period
 This indicates the number of times the stock
in the business has turned over, and the
lower the rate, the longer the stock is taking
to turn over.
 This brings issues about aged and / or over
(excess) stock holdings for the business
resulting liquidity issue.

 Total stock on hand to total assets
 Total stock on hand / Total assets * 100
 This measures percentage of stock on hand
included in the overall assets of the business.
 If high rate of assets is tied up in inventory
and the inventory turnover is relatively low, it
could be a signal of inventory
mismanagement.

 Days Receivables
 Total debtors × days in the period / Total
credit sales of days in the period
 This measure indicates how fast accounts
from the credit sales are being collected.
 Indications of slow paying customers and
potential bad debts.

 Days Payables
 Total creditors × days in the period / The
total cost of goods sold for the period
 This shows how well account payables are
being managed. If suppliers are being paid on
average earlier than the trading terms,
cashflow will be negatively impacted. The
opposite case will be possible relationship
damage with suppliers.

 Total asset turnover
 Net Sales / Total Assets
 This measures the ability of a business to use
its assets to generate sales.
 The lower the total asset turnover ratio, the
more sluggish the business sales are.
 Each asset item should be separately
reviewed to identify the problem areas.

 Return on Assets (ROA)
 Net profit before tax / Total assets * 100
 This ratio indicates how efficiently profits are
being generated from the assets employed in
the business comparing with the benchmark
ratios.

 Return on Equity /Investment (ROI)
 Net profit before tax / Total equity * 100
 This could be the best indicator for business
performance.
 Indicates how well the business efforts
transferred to business returns.
 If ROI is lower than investment returns of
others (such as bank term deposit), this
raises the ultimate question for the
investment itself.

 Business Evaluation

Business Ratios to Analyze Financial Health

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