Using ratios to measure performance

Hamish Mexted Accounting & Compliance, Increasing Profit, Managing Cash

You can drill into your accounting numbers to unlock  a range of information which can help you grow your business.  These numbers can be translated into ratios, giving an insight into what’s happened to an area of your business during the year – for example is the amount spent on wages for each dollar of sales higher this year than it was last year?

Once you understand the ratios you can use them as a scorecard to measure your performance in various areas of your business.  If you don’t have a scorecard of some description it’s impossible to track how you’re going (without just relying on gut-feel).  Calculating and measuring the key ratios for your business is therefore critical for improving your performance.

As mentioned, ratios can help improve various areas of your business, including:

  • Gross profit margins
  • Bottom line
  • Debtor collection times
  • Return on investment
  • Cashflow

… and many other aspects.

A good example of the use of ratios is calculating your debtor days ratio (how long it takes people to pay their bills), with an aim of improving cashflow.  A client was having serious cashflow problems and was unable to identify the cause.  When we sat down with them and calculated the key ratios it became apparent that their debtors were taking an average of 46 days to pay compared with 41 days previously.

Knowing this, we worked with the client to implement a new debtor collection process with the goal of getting average debtor days down to
30.  They’re currently sitting at 39 days so still have a way to go. However their cashflow problems have been reduced remarkably.

Do you calculate the ratios for your business?  How have they helped you?