Go Figure! Calculate Your Key Ratios in 12 Seconds Each!
"So...how's business?"
How many times a month does someone ask you—even in the most casual of ways—how your business is doing?
And how many times does the answer depend almost entirely on the kind of day you’ve had when the question gets asked? Or, even more common, on what your sales trends are.
Here's how to really answer that question: by knowing how you compare to other stores like yours. And not just on sales results, but on the true measures of your viability: your financial strength.
To do that, you simply monitor the true "vital signs" of your business - as measured by key ratios - and compare your performance to benchmark numbers from stores like yours.
Go Figure! Find Your Store's Key Ratios...In Twelve Seconds Each!
You can get a definitive (and non-emotional) financial assessment of your business once you know how to use the numbers on your balance sheet. The Retail Owners Institute has identified some Key Ratios for Retailers to monitor.
These focus on the strength, solvency, profitability and productivity of your operation. And best of all: you can calculate each of them, for yourself, whenever you want – in no more than 12 seconds each!
"Strength": The Debt-to-Worth Ratio
The debt-to-worth ratio is the #1 measure of the financial strength of a business. It compares the amount invested in your business by creditors to that invested by the owners. The more a company is supported by debt, the riskier it is considered. In other words, the higher the ratio the riskier the business. So, debt-to-worth is a measure of the safety of your business.
To calculate debt-to-worth, divide your total liabilities by your net worth (equity). Use the amounts listed on your balance sheet.
Total Liabilities divided by Net Worth = Debt-to-Worth
$300,850 ÷ $99,450 = $3.03
In this example, there are $3.03 of creditors’ funds for every $1 of owners’ funds invested in the business.
"Solvency": The Current Ratio
Current ratio is an indicator of solvency, or the ability to meet your current debt obligations.
The current ratio measures how well you can cover current liabilities with liquid assets. (Or, put another way: it indicates your ability to pay your bills on time!)
Remember, current assets are cash or assets which can be converted to cash in one operating cycle (usually one year). Similarly, current liabilities are debt obligations due within one operating cycle. For retailers, typically the largest amount in current assets is your inventory.
The current ratio is calculated by dividing your current assets by your current liabilities:
Current Assets divided by Current Liabilities = Current Ratio
$378,000 ÷ $300,850 = $1.26
In this example, there is $1.26 of current assets available to cover every $1 of current debt.
"Productivity": Inventory Turnover
Inventory turnover is essential to all retailers, from the newest start-up to Fortune 500 chains. It measures how often, at your present rate of sales, your entire inventory is completely sold and replaced during a given period.
There are two formuals to calculate turns; one uses inventory at cost, the other uses inventory at retail.
Sales @retail divided by Average Inventory @Retail;
or,
Cost of Goods Sold divided by Average Inventory @Cost
COGS ÷ Average Inventory @Cost = Inventory Turnover
$635,000 ÷ $292,500 = 2.2
Theoretically, this means inventory is “sold out” and “replaced” 2.2 times per year. To convert inventory turnover into days, take 365 days and divide by the turnover rate. In the above example, 365 is divided by 2.2. The result is 166 days, which means at any given moment in time, 166 days (or five and a half months) of inventory (e.g., "one turn's worth" of inventory) is the maximum amount of inventory to have on hand.
"Profitability": Profit Before Taxes Percentage
Profit before taxes percentage measures your profitability after sales and all deductible expenses are recognized. It indicates the percentage of original sales dollars remaining as profit, and taxed as such.
The formula is Profit before Taxes divided by Sales.
Profit Before Taxes ÷ Sales = Profit Before Taxes Percent
$10,000 ÷ $1,000,000 = 1%
Using this example, of every $1 in sales, only 1% (1 cent) remains as profit before taxes. (Note: profit before taxes measures your operating efficiency, as opposed to gross margin percentage which measures your sales efficiency.
The Best Part: Compare Your Ratios to Other Stores Like Yours
Once you have these four key ratios, you can readily compare your financial situation to other retail operations like yours. Simply go to your retail segment here at The Retail Owners Institute. See the most recent benchmark numbers for your store type. Even better, spend some time with the charts showing the 5-year trends for your industry.
Use Benchmark Numbers
Go to your retail segment here at The Institute. Spend time with the 5-year trends charts for your industry. How do you compare?
By comparing your ratios with industry standards, you can note whether your ratios are more or less favorable than other businesses within the industry. Higher is not always better. For instance, a higher debt-to-worth means more debt—which is not necessarily more desirable.
Keep in mind that no one ratio, even compared to industry averages, tells as much about your operation as the trend of your ratios. For example, has your current ratio dropped (liquidity lessening) over the last year? If so, what will it be in another six months? What action(s) must you take to prevent a slip from continuing?
You may find it helpful to write down your reasoning. By facing the facts now, you’ll be better prepared for those unexpected ups and downs.