Five financial ratios your clients need to be in the know on
February 25, 2023
There is tremendous value in having accounting clients that are actively engaged in their financial matters and performance. Not only do they benefit from gaining transparency and the feeling of autonomy over how their finances are handled, but it can also make all the difference when it comes to making well-informed decisions about their finances and investments.
Business owners are busy people, but even with everything that they have on their plates, having an understanding of their financial ratios is worth the effort and will give them a fulsome picture of their organizational financial health.
InterVal is a business valuation monitoring platform that offers a better way for financial planners to help their business owner clientele. InterVal leverages real-time valuation data to make better and more informed business decisions. Including financial ratios that give business owners rich insights into their organizational financial health no matter where they might be in their ownership journey. Here we review six key financial ratios that the InterVal platform highlights for painting that organizational health picture.
The current ratio is a liquidity measure that takes current assets and divides it by current liabilities within a given period. These assets typically include items like cash, inventory, and accounts receivable. Monitoring this ratio can alert business owners to any potential issues before they become problematic. An optimal current ratio tends to depend on the sector you’re in, but generally speaking it’s prudent to aim for somewhere between 1.5 and 2.
2. Debt Ratio
Managing debt is one of the toughest decisions any business owner has to make and a healthy debt ratio is key to a firm's success. Debt ratio, also known as leverage ratio or debt-to-assets ratio, is represented as a percentage where anything over 100% indicates that a company is heavily in debt. While there isn't an optimal debt ratio for all businesses and industries, it's key to stay aware of financial obligations and ensure that debt is being used responsibly rather than relying too heavily on it.
3. AR Turnover Ratio
The Accounts Receivable (AR) turnover ratio indicates how quickly the company collects its debts. Business owners need to keep an eye on this ratio to ensure that they are collecting payments in a timely manner and while managing credit terms properly. A higher AR turnover ratio means that the debtors are paying quicker, allowing a business to flow more freely without worry of backlogged unpaid invoices. Two to five days is generally considered to be an ideal AR turnover ratio for most large companies.
4. Inventory Turnover Ratio
Inventory turnover ratio measures the number of times that a company sells off its inventories over a given period. Keeping track of inventory turnover helps business owners make sure their resources are effectively utilized and gives insights into how well their stock is moving. Too low a ratio means there are too many products sitting in the warehouse, while too high may mean understocking which can lead to lost sales opportunities. Striking the optimal balance between these extremes is key – having just enough resources without being stuck with unsold goods. An inventory turnover ratio between 2-6 is ideal.
5. Revenue to Equity Ratio
The revenue to equity ratio is calculated by dividing a business' total revenue by its total equity. Monitoring this ratio is important because it reveals how effectively a company is using its resources. Business owners need to keep an eye on this figure, as a lower value may indicate that they are not utilizing their resources as efficiently or leveraging them as effectively as they could be. Maintaining the optimal revenue to equity ratio of 2:1 or higher helps businesses maximize returns on investment.
Analyzing Saleability of a Business
The InterVal platform also provides a saleability analysis for business owners. By taking data and ratios, InterVal is able to provide business owners with a report that ranks their organizational saleability as green, yellow, or red based on a range of factors including:
- Business location;
- Industry that the organization operates in;
- Percentage of revenue that is generated by top five customers;
- Whether business revenues are concentrated to a specific time of year; and
- Total employee numbers and functions.
If you’d like to find out more about interVal and Integrated Advisory, please contact us. Alternatively, if you have a client who would benefit from a high-level analysis of the value of their business, please let us know.
The Integrated Advisory Community consists of a network of progressive CPA firms, along with best-in-class professional advisors, service, and product specialists, who work together to deliver an elevated and holistic client experience. One that optimizes both their personal and professional lives with an integrated financial strategy designed to help clients reach their goals.
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