Useful Management Ratios

Accounting management ratios are a highly effective tool to assist you in monitoring and analysing various aspects your business. These ratios will provide you with information that is vital to the smooth running of your business.

Profitability Ratios:

1. Operating Profit Margin (%)

Operating Profit x 100

This ratio measures your net trading profit. For a small business this percentage should always be more than 10% which means that after expenses, the profit should be more than ten cents from each dollar of sales.

2. Gross Profit Margin (%)
Gross Profit x 100

Your Gross Profit Margin measures your trading profit before expenses are paid and indicates whether your mark-up is adequate. This ratio, in most businesses, is greater than 33%. Each industry has averages which can be used as a benchmark.

3. Profit Mark-up (%)
Profit x 100

This expresses the mark-up as a percentage of the cost.

4. Net Profit Margin (%)
Net Profit x 100

This ratio shows your net profit margin prior to deducting interest on borrowings and income tax.

5. Net Profit = Gross Profit – Expenses

Refer to industry averages and published statistical data to compare your net profit.

Liquidity Ratios:

6. Current Ratio = Current Assets: Current Liabilities

Current assets should be twice the value of current liabilities, hence the ratio should be greater than 2, for the business to be in a good liquid position and able to meet all future commitments.

7. Acid test = (Current Assets – Stock): Current Liabilities

If this ratio is greater than 1, it indicates that the business is in a good position. It means that your accounts receivable is greater than your accounts payable.

Efficiency Ratios:

8. Total asset turnover
Total Assets

This accounting management ratio shows how efficiently your total assets are being utilised by the business. If the ratio is less than 1, you will need to analyse your assets to ensure that you have not invested too heavily in non-productive assets.

9. Stock Turn
Average Stock
(Cost of Sales/365)

This is a very important ratio and shows how quickly you are converting stock into sales. Generally a good stock turn ratio is 4 (turning over stock every 3 months) but averages vary depending on the industry. Stock turn, measured in days, will be high if you are carrying excess stock or redundant stock.

10. Trade Debtors
Average Debtors
(Credit Sales/365)

This ratio indicates your level of outstanding accounts receivable and measures how quickly you are collecting outstanding debts from customers.

11. Trade Creditors
Average Creditors

Similarly, this ratio measures how quickly you are paying your accounts. If this ratio, measured in days, is high it could lead a breach of your suppliers ‘trade terms’.

12. Gearing Ratio
Long-term Liabilities
Equity Shareholder Funds

This accounting management ratio measures your longer-term borrowings as against the equity in your business. Your equity should be greater than these borrowings. Borrowings may increase, depending on your circumstances, but they need to be managed very carefully to ensure that repayments can be made on due dates or renegotiated on favourable terms.

13. Operating Cycle
Average Debtors
(Credit Sales/365)
(Cost of Sales/365)

This ratio shows how efficiently you are converting stock purchases into sales through to trade debtors then to cash in the bank and finally pay creditors. The quicker the turn-around, the more efficiently you are converting stock into cash-flow. A short operating cycle is optimal for cashflow and profitability as there is less chance of obsolescent and slow moving stock accumulating and similarly fewer bad debts, resulting in funds being more readily available to deposit and pay trade creditors. The ratio is determined by the number of days that stock is held plus the number of days required to collect the debt.

Other accounting management ratios and analytical tools, specific to your business, can be supplied on request.