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In addition to having a great product, good sales, good SEO, great marketing, etc., there is one thing that is vital to the long-term growth and success of a startup: good bookkeeping.
And yes … you may not be as well versed in numbers as your accountant. But understand: it is essential to have a working knowledge of an income statement, balance sheet, and cash flow statement.
And along with that, a working knowledge of key financial ratios.
And if these ratios are understood, you will become a better entrepreneur, administrator, company to buy and yes … investor.
Because YOU will know what to look for in an upcoming company.
So here are the key financial reasons every startup should:
1. Working capital ratio
This ratio indicates whether a company has enough assets to cover its debts.
The relationship is Current Assets / Current Liabilities.
(Note: current assets refer to those assets that can be converted into cash within a year, while current liabilities refer to those debts that mature within a year)
Any value below 1 indicates negative W / C (working capital). Although any value greater than 2 means that the company is not investing assets in excess; A ratio between 1.2 and 2.0 is sufficient.
So Papa Pizza, LLC has current assets of $ 4,615 and current liabilities of $ 3,003. Your current ratio would be 1.54:
($ 4.615 / $ 3.003) = 1.54
2. Debt / equity ratio
This is a measure of the total financial leverage of a company. It is calculated by Total Liabilities / Total Assets.
(It can be applied to both personal and corporate financial statements)
David’s Glasses, LP has a total liability of $ 100.00 and the capital stock is $ 20,000, the debt / equity ratio would be 5:
($ 100,000 / $ 20,000) = 5
It depends on the industry, but a ratio of 0 to 1.5 would be considered good, while anything above that … not so good!
Right now, David has $ 5 of debt for every $ 1 of equity … he needs to clean up his balance sheet fast!
3. Gross profit margin ratio
This shows the financial health of a business to show revenue after deducting the cost of good sold (COGS).
It is calculated as:
Income – COGS / Income = Gross Profit Margin
Let’s use a larger company as an example this time:
DEF, LLC earned $ 20 million in revenue by incurring $ 10 million in COGS-related expenses, so the gross profit margin would be% 50:
$ 20 million- $ 10 million / $ 20 million = .5 or% 50
This means that for every $ 1 earned you have 50 cents of gross profit … not bad!
4. Net profit margin ratio
This shows how much the company made in TOTAL profit for every $ 1 it generates in sales.
It is calculated as:
Net Income / Income = Net Profit
So Mikey’s Bakery made $ 97,500 in net profit on revenue of $ 500,000, so the net profit margin is% 19.5:
$ 97,500 of net profit $ 500,000 of revenue = 0.195 or% 19.5 of net profit margin
For the record: I excluded operating margin as a key financial index. It is a large proportion, as it is used to measure the pricing strategy and operational efficiency of a company. But just excluded it doesn’t mean you can’t use it as a key financial index.
5. Accounts receivable turnover rate
An accounting measure used to quantify the effectiveness of a business in extending credit and collecting debts; In addition, it is used to measure the efficiency with which a company uses its assets.
It is calculated as:
Sales / Accounts Receivable = Turnover of Accounts Receivable
So Dan’s Tires, which made about $ 321,000 in sales, has $ 5,000 in accounts receivable, so the accounts receivable turnover is 64.2:
$ 321,000 / $ 5,000 = 64.2
So this means that for every dollar invested in accounts receivable, $ 64.20 goes back to the company in sales.
Good work Dan !!
6. Return on investment ratio
A performance measure used to evaluate the efficiency of an investment to compare it to other investments.
It is calculated as:
Investment Profit-Investment Cost / Investment Cost = Return on Investment
So Hampton Media decides to fork out a new marketing program. The new program cost $ 20,000 but is expected to generate $ 70,000 in additional revenue:
$ 70,000- $ 20,000 / $ 20,000 = 2.5 or 250%
Therefore, the company seeks a return on investment of 250%. If they get close to that … they’ll be happy campers 🙂
7. Ratio of return on capital stock
This ratio measures the profitability of a company with the money that shareholders have invested. Also known as “return of new value” (RONW).
It is calculated as:
Net Income / Stockholders’ Equity = Return on Equity
ABC Corp shareholders want to see how well management is using the invested capital. So after reviewing the books for fiscal year 2009, they see that the company made $ 36,547 in net income from the $ 200,000 they invested to make an 18% return:
$ 36,547 / $ 200,000 = 0.1827 or 18.27%
They like what they see.
Your money is safe and it’s generating a pretty solid return.
But what are your thoughts?
Are there any other key financial ratios that you have overlooked?