What Is The Formula To Compute The Return On Assets Ratio Analysis Techniques for Improving Your Small Business

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Ratio Analysis Techniques for Improving Your Small Business

Ratio analysis allows you to identify trends and measure business performance, providing critical information that allows you to identify and resolve problems before they reach your business.

Although relationship analysis can be inherently difficult. As a small business owner, you can calculate some key ratios to determine liquidity (does my business have enough cash to cover expenses), activity (does my business generate good returns), and profitability (does my business make the profit margin I expect). Let’s look at these relationships in more detail.

1. Liquidity Ratios – Measures your ability to meet your short-term goals. For example: Can you pay all your bills using your balance today? For this answer, we will use the quick ratio formula.

Quick Ratio=current assets-inventory-current liabilities;

In this example we will use a service company that we will ignore

Let’s say your current assets are $10,000 in cash, $15,000 in accounts receivable, and $8,000 in common stock.

Your liabilities are $30,000 in accounts payable and $8,000 in accounts payable.

Your target ratio > 1.1

$33,000 = 0.87

$38,000

Problem: Your current liabilities exceed your current assets.

Solution: Set new terms for your claims or find ways to increase your cash flow. See numbers never lie, so use this new information to implement a strategy aimed at increasing your current assets.

Next, let’s look at activity relationships

2. Activity Ratios – Measures how efficiently your company’s resources are being used (average collection period, inventory turnover). For this example, let’s look at the inventory turnover of a discount store, e.g. 99 stores.

Inventory Turnover – Measures how many times inventory is turned over in a given year. The higher the turnover ratio, the better. Now, to calculate this ratio, you should know what the standard ratio is for your industry. A quick Google search for your industry will provide this information.

Let’s say your cost of goods sold was $150,000 and your inventory is worth $80,000

Example: Discount store

Industry Standard Ratio 4

Cost of goods sold = $150,000 = 1.9

Inventory $80,000

Problem: Your inventory turnover rate is much slower than your industry average.

Solution: Add an automated inventory system that keeps track of how much inventory you have at any given time. So you don’t buy excess inventory. Understanding inventory management is critical to increasing your sales and maximizing your profits!

Hopefully you now understand how relationship analysis can improve and grow your small business.

Finally, let’s look at profitability

3. Profitability Ratios- is a group of financial ratios that measure sales and return on investment

Example: A high-end boutique that sells high-priced items and your target profit margin is > 15% of sales. Your sales for the year are $350,000. Your net profit after taxes is $60,000

Net profit after tax = $60,000 = 17.1%

Sales $350,000

In this example, you exceed your target profit by 2%! You’re making money, your business is growing, and business is good!

As we saw above; using ratio analysis is a simple yet effective way to increase business performance and promote business growth.

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