Financial statements contain the answers to most business questions, but raw totals are hard to compare across months or against your goals. Ratios turn them into a few numbers you can track. They are only as good as the underlying books, so they assume reconciled statements; see how to read a profit and loss statement and how to read a balance sheet.

Profitability

Gross margin = (revenue − cost of goods sold) ÷ revenue. It shows how much of each sales dollar remains after direct costs. A falling gross margin often signals price pressure, supplier cost increases or waste.

Net profit margin = net profit ÷ revenue. It shows what is left after all expenses. Compare it month to month and over trailing 12 months to smooth seasonality.

Owner's view: for small businesses, add back owner compensation to see what the business earns before paying the owner, which helps compare businesses with different pay arrangements.

Liquidity

Current ratio = current assets ÷ current liabilities. Below 1 means short-term obligations exceed short-term resources. A very high ratio may mean idle cash or slow receivables.

Cash runway = cash ÷ average monthly net cash outflow, useful for businesses not yet profitable.

Working capital efficiency

Days sales outstanding (DSO) = accounts receivable ÷ revenue × days in period. It shows how long customers take to pay. See accounts receivable for small businesses.

Days payable outstanding = accounts payable ÷ cost of purchases × days. It shows how long you take to pay suppliers.

Inventory turnover = cost of goods sold ÷ average inventory. Low turnover ties up cash; see inventory accounting basics.

Leverage

Debt to equity = total liabilities ÷ owner's equity. Lenders watch it.

Debt service coverage = cash available for debt service ÷ principal and interest payments due. Many loan agreements set a minimum.

Industry measures

Some industries have their own key measures: labor cost percentage in restaurants, cost per mile in trucking, utilization in professional services. These often matter more than general ratios.

How to use ratios

  1. Choose five or six that matter for your business
  2. Calculate them monthly from reconciled books
  3. Watch the trend rather than any single month
  4. Investigate sudden changes

Benchmark comparisons can be useful, but your own trend is the most reliable reference. The SBA's guidance on managing your finances emphasizes regular review. Our accounting services include a monthly ratio dashboard.

Reliable inputs

Ratios are only as good as the books. Reconcile accounts and close the month before calculating them.

Key terms

Definitions for terms used in this guide, from our small business glossary:

  • Accounts Receivable: Accounts receivable is money customers owe your business for goods or services already delivered.
  • Accounts Payable: Accounts payable is the money your business owes suppliers and vendors for goods or services received but not yet paid for.
  • Assets: Assets are resources a business owns or controls that are expected to provide future economic benefit.
  • Liabilities: Liabilities are amounts a business owes to others, such as suppliers, lenders, employees and tax authorities.
  • Owner's Equity: Owner's equity is the owners' stake in the business: assets minus liabilities.
  • Cost of Goods Sold: Cost of goods sold is the direct cost of the products a business sold during a period.
  • Working Capital: Working capital is current assets minus current liabilities, the resources available to run day-to-day operations.
  • Liquidity: Liquidity is a business's ability to meet short-term obligations with cash or assets that can quickly become cash.