“Removing Roadblocks on Your Path to Success”
Accounting Ratios are the Vital Signs of a Business
One of the best ways to monitor your company’s financial health and increase its profitability is to use accounting ratios. They are the vital signs of every business because they give Business Owners a clear picture of their organizations’ performance.
Accounting Ratios (or Financial Ratios) are fundamental to Financial Statement analysis. They relate one part of a Financial Statement to another or different financial reports to one another. They can be used to compare your financial position to an industry standard or to measure your improvement year to year.
Benefits of Accounting Ratios
Stockholders, investors and customers use financial data to measure the solvency, sustainability and profitability of your business model. Make sure your financial key performance indicators are working for you rather than against you.
The current ratio is a financial ratio that investors and analysts use to examine the liquidity of a company and its ability to pay short term liabilities (debt and payables) with its short term assets (cash, inventory and receivables). The current ratio is calculated by dividing current assets by current liabilities.
For example, if your company has $22,500 in cash and $15,000 in accounts payable, your current ratio would be 1.5:1 ($22,500 in cash divided by $15,000 in accounts payable). A high current ratio indicates solvency and sustainability. A current ratio of between 1.5:1 and 3:1 is considered healthy. A current ratio of less than one indicates your company may not be able to meet its current financial obligations.
A low current ratio is a common problem we see with most businesses. It occurs when business owners use short term debt to finance their growth by using credit cards and credit lines. When a company needs financing to grow their company and the business owner has used the wrong vehicle to fund that growth, the business is a higher lending risk to banks. This is something that can be easily avoided with good planning and by using Pacific Crest Group’s Chief Financial Officer (CFO) services to assist in getting the right credit facilities in place from the very beginning.
If your current ratio is more than three to one, it could indicate your company is holding excess cash instead of investing it back into the business. This will significantly slow the growth of your organization.
The current ratio provides owners, investors and financial professionals a substantial amount of information about the efficiency of your company’s business. It answers the crucial question: “Can your business generate a consistent revenue stream over a specific period of time?”
Return on Equity
A very powerful way to measure your company’s profitability is the Return on Equity ratio. It is calculated by taking the organization’s net earnings after taxes subtracting preferred dividends and dividing the result by common equity.
Return on Equity shows how much profit an entity generates relative to the amount the business owners have invested in the business.
Key Performance Indicator Guideline
Pacific Crest Group’s Key Performance Indicator Guideline describes frequently used metrics and how to use them. It provides a case study, sample forms and charts for your use.
How We Can Help You
Pacific Crest Group (PCG) provides professional services that keep your business focused on your critical objectives. We provide strategic Accounting and Human Resource (HR) services created specifically to help you meet your goals. Through exemplary customer service, clearly defined policies and procedures as well as a forward looking perspective, we provide the outsourced solutions your business needs to grow. A PCG professional is happy to meet with you to discuss solutions for your unique requirements designed to maximize all of your business opportunities.
This newsletter is intended to provide generalized information that is appropriate in certain situations. It is not intended or written to be used, and it cannot be used by the recipient, for the purpose of avoiding federal tax penalties that may be imposed on any taxpayer. The contents of this newsletter should not be acted upon without specific professional guidance. Please call us if you have questions.
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