5 Ways to Measure Business Efficiency

Financial ratios can be used to measure business efficiency, and once you understand them, you'll be guided in the right direction. Some ratios can even indicate how long your business would be able to survive, or forecast cash shortfalls. Your small business accountant could run the numbers, but why not do it yourself and save some money. Here are the top 5 ratios you need to know about:

1 - Net Profit Margin

Every business owner needs to know what the net profit margin for their business. For every sales dollar you make, the following ratio will help you figure out the net profit margin: Net profit after taxes, divided by, total sales. High net profit margins indicate good business efficiency. It’s one of the most important numbers to know, because it will indicate problems with sales volume compared to expenses.  You can decide how to deal with any issues then, such as reduce costs or increase sales.

2 - Accounts Receivable Turnover

Business efficiency can be improved by the way that you handle your accounts receivables. The financial ration that measures accounts receivable turnover, for example, is this: Total net sales, divided by, accounts receivable. The accounts receivable in that formula is the number of receivables paid during a fixed period. An efficient business is one in which the "turnover" is high, because that means that the sales are converted into cash quickly. The faster you can convert sales into cash, the more you'll have on hand to pay yourself, pay the bills and reinvest in the business.

3 -  Accounts Payable Turnover

You also need to keep tabs on how fast you’re paying suppliers during a fixed accounting period. The accounts payable turnover is measured by this formula: Cost of goods sold, divide by, accounts payable (the number of accounts). The higher the number, the more you’re unable to pay suppliers on time, or choose not to. Paying suppliers on time leads to business efficiency, and protects your reputation. If you don’t, they may decide not to do business with you.

4 - Current Liquidity Ratio

When you incur liabilities for your business, efficiency becomes a game of playing catch-up. Debt can drag down your business, but if you’re in it, you need to keep abreast of the current liquidity ratio: current assets, divided by, current liabilities. This ratio lets you know whether you have enough assets to cover your liabilities. For example, if the answer to the formula is three, that means that you have three times as many assets than liabilities. Zero or a negative ratio indicates that you owe more than you own.

5 - Inventory Turnover

Any product based business needs to regularly assess the inventory turnover ratio. This ratio shows how fast it takes for the inventory to be sold. It impacts storage, ordering and shipping. To figure out the inventory turnover, divide the cost of goods sold by the total inventory in one accounting period.

These are the top financial ratios that you calculate at least monthly to determine your business efficiency. You don’t want to wait until a problem arises.

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