|
INDUSTRY FINANCIAL BENCHMARKING
If you would like to reveal and quantify areas of strength and weakness within your small business, determine where you stand in your industry and correct competitive weakness, learn whether your business is creating wealth and capital as successfully as your competitors, see the distance between goals and reality, and discover where productivity is lacking, we can help you do all that.
By providing us with some key financial data about your company, it can be measured against similar companies in the same industry with the goal of improving performance and profitability. A customized report will be generated and sent to you.
The report will focus on key financial ratio. It will provide you with your profitability ratios, operating ratios, liquidity ratios, and solvency ratios, all for your business and for your industry. Based on your report, you will then determine the areas of strength and weakness in your business and act accordingly. You will be able to modify your business plan based on facts, to achieve your strategic goals and improve performance and profitability.
LIQUIDITY RATIOS
Current Ratio
Formula: Current Assets divided by Current Liabilities
The current ratio helps determine if there is enough working capital to meet short term financial obligations. A general rule of thumb is to have a current ratio of 2.0. Although this will vary by business and industry, a number above two may indicate a poor use of capital. A current ratio under two may indicate an inability to pay current financial obligations with a measure of safety.
Quick Ratio
Formula: Current Assets minus Inventory divided by Liabilities
Also known as the 'Acid Test', the Quick Ratio helps gauge the immediate ability to pay financial obligations. Quick Ratios below 0.50 indicate a risk of running out of working capital and a risk of not meeting current obligations. The higher the ratio, the stronger the business. While industries and businesses vary widely, 0.50 to 1.0 are generally considered acceptable Quick Ratios.
Working Capital to Sales Ratio
Formula: Working Capital divided by Gross Sales
Working capital is used by a lender to help gauge the ability of a company to weather difficult financial periods. Working capital is calculated by subtracting current liabilities from current assets. Due to differences in businesses and the fact that working capital is not a ratio but an absolute amount, it is difficult to predict the ideal amount of working capital for a business without making use of other financial measures, including the Quick Ratio and the Current Ratio. Dividing the working capital by sales, measures how much working capital is required for a certain sales level. It also provides insight into the degree of protection afforded current creditors.
PROFITABILITY RATIOS
Gross Profit Margin
Formula: Gross Profit divided by Sales
This important ratio measures profitability at the most basic level. The total gross profit (which is net sales minus cost of goods sold) compared to net sales. A ratio less than one means the products are sold for less than it cost to produce. If this ratio remains less than one, profitability will not be achieved, regardless of the volume or the efficiency of the rest of the business. This financial ratio tends to remain stable over time. Significant fluctuations can be a sign of fraud or financial irregularities.
Net Profit Margin (Return on Sales Ratio)
Formula: Net Income divided by Sales
Often referred to as the bottom line, and also known as the Return on Sales, this ratio takes all expenses into account including interest.
Operating Profit Margin
Formula: Operating Income divided by Sales
This ratio measures profitability based on earnings before interest and tax (EBIT). This measure is used to gauge the efficiency of the business before taking any financing means into account (such as debt financing and tax considerations). This ratio is often used to compare the operating efficiency between similar businesses.
Return on Assets
Formula: Net Income Before Taxes divided by Total Assets
This ratio helps show how assets are being used to generate profits. One of the most common financial measures, it can be an effective tool to compare the profitability of two companies. If the return on assets is lower than a competitor, it may be an indication that they have found a more efficient means to operate through financing, technology, quality control or inventory management.
Return on Equity
Formula: Net Profit divided by Equity (Total Assets minus Total Liabilities)
The return on equity ratio reveals how much profit a company earned in comparison to the total amount of equity on the balance sheet. Companies that have high return on equity ratios can provide the biggest payoff. A business that has a high return on equity is more likely to be one that is capable of generating cash internally. For the most part, the higher a company's return on equity compared to its industry, the better.
OPERATING RATIOS
Assets Turnover Ratio
Formula: Net Sales divided by Total Assets
The business’s ability to generate sales from the total assets is measured here. Higher ratios suggest a greater capacity to create sales with given assets.
Sales to Fixed Assets
Formula: Gross Sales divided by Fixed Assets
This ratio indicates the management’s productive use of the fixed assets to generate sales. It also tests the efficiency in keeping production assets employed.
Sales to Receivables Ratio
Formula: Net Sales divided by Net Receivables
This ratio measures the number of times the receivables 'turned over'. The higher the number, the more efficient accounts receivable are being collected. A ratio that is too high or one that is increasing over time, may indicate an inefficient use of the working capital. It is important to compare this ratio to other businesses in the same industry.
Sales to Working Capital
Formula: Gross Sales divided by Working Capital
This measures the business’s ability to generate sales with its working capital. It is the inverse of working capital to sales ratio.
EFFICIENCY RATIOS
Days in Accounts Receivable
Formula: Accounts Receivable divided by (Gross Sales divided by 365)
This is defined as the average number of days required to collect an account receivable. The lower the better, since receiving payment quicker enhances the cash flow.
Days in Accounts Payable
Formula: Accounts Payable divided by (Cost of Sales divided by 365)
This is defined as the average number of days required for the business to pay an account payable. It may be better to have a high number of days, however, the high number may indicate difficulties in meeting payment obligations. The lower the days the better the performance. Sometimes, another ratio is used, which is the Accounts Payable Turnover, calculated by dividing the cost of sales by accounts payable.
Inventory Turnover Ratio
Formula: Cost of Goods Sold divided by Inventory
This ratio measures the number of times the inventory 'turned-over' during a time period. Generally, the higher this ratio, the better the use of inventory. Low numbers indicate a large amount of capital tied up in inventory that may be more efficiently used elsewhere.
Days in Inventory
Formula: 365 divided by (Cost of sales divided by Inventory)
This is an alternative to the Inventory Turnover, to express the number of days required to sell the business’s inventory. The lower the number, the better for the business.
Operating Cycle
Formula: Days in Inventory plus Days in Accounts Receivable
This is the average number of days between purchasing raw materials or resalable inventory and the collection of cash as a result of the sale of that inventory. The lower this value the better the business.
SOLVENCY RATIOS
Accounts Payable to Inventory
Formula: Accounts Payable divided by Inventory
This is a measure of how much inventory is financed by vendors. This is an important measure to find out the inventory financed by the business’ vendors.
Debt to Equity Ratio
Formula: Total Liabilities divided by Net Worth
Also called the leverage ratio, it is used to help describe how much debt is used to finance the business. While some debt may be prudent, depending on too much debt financing can increase risk.
Interest Coverage Ratio
Formula: Earnings Before Interest and Taxes (EBIT) divided by Interest Expense
The interest coverage ratio is a measurement of the number of times a company could make its interest payments with its earnings before interest and taxes; the lower the ratio, the higher the company’s debt burden. An interest coverage ratio below 1.0 indicates the business is having difficulties generating the cash necessary to pay its interest obligations.
Fixed Assets to Equity
Formula: Fixed Assets divided by Equity
The ratio measures the business owner’s investment in fixed assets, and can reflect over-investment or under-investment by owners. A lower, or positive ratio value is more favorable for creditors in case of liquidation of the company, negative values indicate negative equity, usually the result of negative retained earnings. If most of the assets are leased or if the assets are essentially depreciated, this ratio becomes less meaningful. Note that for businesses that operate with no fixed assets, this ratio value will be zero.
Cash Flow to Current Maturity of Long Term Debt
Formula: Cash Flow divided by Current Maturity of Long Term Debt
Cash Flow is defined here as the net income before taxes and depreciation. This ratio provides an insight into how well the business is able to meet its current obligations on long term debt through its cash flow. The higher this value the better the business.
|
