Tracking a company’s financial performance is very important. It provides insight into how profitable your business is, how efficient it is, and how its state of liquidity is. Moreover, this knowledge is crucial to owners, CFOs, and investors for a multitude of reasons. Now, how is this performance measured exactly? Well, that’s where financial ratios come into the equation! So today, we’re gonna break down how these ratios can help you measure all that and more. After all, if you wanna successfully run a business in Dubai, you should know your basics!
The Quick Financial Ratios Rundown!
Okay so, as we already mentioned, you will need a way to track your company’s financial performance. And for that, financial ratios are the solution! There is a ratio to help accountants measure almost everything. From income and profit to debts and equity, anything that has a price tag can be calculated. So, let’s check out some ratios that every accountant (or SME owner) should know.
Current Ratio
Current Ratio = Current Assets / Current Liabilities
This ratio is important for investors because it gives them an idea on the ability of a company to pay its obligations short-term. Sometimes this ratio is also referred to as the Working Capital Ratio. It is very important because it ensures that companies maintain a healthy amount of liquidity. If this financial ratio is over 1, that means the business has the resources to stay solvent on the long-term. However, this ratio’s shortcoming is that it cannot predict the state of the company long-term.
Quick Ratio
Quick Ratio = (Current Assets – Inventory) / Current Liabilities
The Quick Ratio, aka Acid-Test Ratio, is very similar to the current ratio with a little twist. This ratio actually measures the ability of a company to pay its short-term obligations with only the assets that can be liquidated quickly without having to sell the inventory. Now that comes in handy in case you own a business with slow-moving inventory like manufacturing.
Gross Profit Margin
Gross Profit Margin = (Revenue – Cost of Goods Sold) / Revenue
This equation can tell you how much profit your business will make after deducting business costs. These costs include sales, general, and administrative costs. And this percentage, which on average ranges between 5-10% can give you insight on your pricing strategy. That way, you will know whether you are appropriately pricing your product thanks to this financial ratio.
Return on Assets (ROA)
ROA = Net Income / Total Assets
Basically, this formula assesses how well a company can generate profit from its assets. This is especially helpful when you wanna see how your company is doing in comparison to competitors in the same industry. The higher the ROA is, the better the company is doing!
Return on Equity (ROE)
ROE = Net Income / Total Equity
Last but not least, this formula is a measure of a business’ financial performance. While the ROA measures profit relative to assets, the ROE measures how well a company can generate profit relative to shareholders’ equity. Now, total equity is calculated by deducting the company’s debts from the total assets. So technically, ROE is the net income divided by net assets.
Need Help with Your Financial Assessments?
All the financial ratios that we already covered, and many more, can greatly help you assess the financial health of your business. Now, if you don’t have any accounting background and wanna ensure smooth operations, we got you. At Noraal, our certified experts can handle your accounting needs from A to Z! That way, you’ll be able to focus on what matters: your growth and success. So, contact us today for a free consultation, and you’ll never have to look back!