Remember These Ratios to Keep Your Business in Balance

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Photo: {Jadranka} via Flickr

Note: A version of this post was originally published on OPEN Forum.As you start your own business, it’s important to keep things in balance.

Financial ratios are a crucial tool for keeping track of how your business is doing and shouldn’t be overlooked.

The most important ratios have to do with your balance sheet,” says Robert M. Pesce Jr., Partner-in-Charge of Accounting Services at Marcum LLP. 

A crucial metric for small business is the current ratio, which “measures your assets against your liabilities: you don’t want that to be less than one to one. A healthy firm will be closer to 2 to 1, meaning you’ll have twice as many assets as liabilities,” says Pesce.

Assets represent the economic resources of your company. This could be cash, or anything your company can turn into cash, like inventory, buildings or equipment. Liabilities represent an obligation that will diminish your company’s assets. That could be payments on a loan, wages or taxes.

“Companies should also look at their receivables; since everyone is taking longer to pay,” Pesce says. Companies should think about their DSO, or Days Sales Outstanding; this is a measure of how long it takes to get paid by clients after they use your service. “You’d like to collect your account receivables with 45-60 days. It’s ideal to get them within 30 days. It also depends on the industry. If you’re in the business of selling perishables, your DSO will be lower.”

Pesce says accounts receivable should not be more than twice your monthly sales. This is called the receivable turnover ratio or working capital ratio. The working capital ratio is current assets divided by current liabilities.

“You also hear about ROI (return on investment),” Pesce says.  “A small business owner isn’t concerned with that.  Their company is their investment. ROI is used for shareholders.”

You’re a small business, not a bank, so don’t get bogged down in financial terms. But keeping these ratios in mind will help your company to stay afloat even in difficult times.

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