Check These Ratios Before It's Too Late And You Go Bankrupt

financial ratios

For small business owners, keeping a close eye on financial health is crucial for long-term success. While profit and loss reports are often monitored (and rightly so), many tend to overlook the valuable insights provided by the balance sheet report. Neglecting the balance sheet can lead to missing warning signs and potential cash flow issues.

In this article, we’ll delve into a range of essential financial ratios that every small business should examine closely. These ratios are key indicators of your company’s financial health and can help you assess whether you’re managing your cash flow effectively or steering toward dangerous waters. By incorporating these ratios into your financial analysis, you’ll gain a deeper understanding of your business’s performance, identify potential cash flow pitfalls, and take proactive measures to safeguard your financial stability.

An accountant’s expertise when it comes to financial health, tax regulations, and error detection is imperative for the long-term success and growth of your small business. At Joanna Bookkeeping, we understand that implementing the right financial strategy is key when it comes to running your business, so we want to help you make sure everything goes smoothly from the get-go.

We help ambitious SMEs in Oxford maximise their potential by providing effective accounting & bookkeeping services to business owners of all sizes from all over the UK.

Book a call with one of our Oxford-based accountants and bookkeepers, and let’s have a chat.

Let’s get into these four important financial ratios provided by the balance sheet report…

Quick Ratio

The quick ratio is a key indicator of a company’s liquidity and ability to meet short-term obligations. Calculated as:

(current assets – inventory) / current liabilities

A significant drop in this financial ratio each year may signal serious cash flow issues. However, it’s essential to consider that businesses with low levels of debtors may naturally have a lower quick ratio. Monitoring this ratio can help you identify potential liquidity challenges and take proactive measures to address them.

Average Debtor's Collection Period

The average debtor’s collection period sheds light on how quickly a company collects money from its clients. To calculate this financial ratio, use the formula:

(trade receivables * 365) / sales

A decreasing average debtor’s collection period is ideal, as it indicates efficient cash flow management. Conversely, if this ratio increases each year, it may signal that clients are taking longer to pay, impacting your cash flow negatively.

Average Creditor's Collection Period

This financial ratio shows how long it takes your business to pay suppliers. Calculate it using:

(trade payables * 365) / credit purchases or cost of sales

It’s essential to compare this ratio with the average debtor’s collection period. If you’re paying suppliers quicker than you’re getting paid by clients, it can lead to negative cash flow dynamics. On the other hand, a longer creditor collection period may strain cash flow and affect your supplier relationships.

Your partner in business

Looking for an accountant who can help you grow your business by providing invaluable insights?

We can help you with business reporting that will give you the information you need to run a successful business.

Average Inventory Holding Period

The average inventory holding period highlights how long your stock stays in inventory before being sold. Calculate it with:

(closing inventory * 365) / cost of sales

A higher ratio implies more money tied up in stock, limiting your ability to invest or pay suppliers. Managing inventory efficiently is crucial to maintaining healthy cash flow and optimising working capital.

The balance sheet is a treasure trove of financial information that businesses should regularly analyse alongside profit and loss reports. By paying attention to the four critical financial ratios, you gain valuable insights into your business’s financial health and long-term prospects. Monitoring these ratios enables you to make informed decisions, address cash flow issues proactively, and steer your business away from the path of bankruptcy. Remember, it’s not just about profitability; cash flow management is equally vital for sustainable growth and success.

Don’t ignore the clues the balance sheet provides; instead, use these financial ratios as your financial compass, guiding your business toward a prosperous future. Regularly evaluating your financial performance and cash flow will empower you to navigate challenges, seize opportunities, and thrive! Stay proactive, stay informed, and secure your business’s financial stability for years to come.

Have a chat with an accountant who understands your responsibilities as a business owner, by booking a call with our Oxford-based accountant. We’re able to offer support and give you expert advice when it comes to a wide range of accounting, bookkeeping, and tax topics and make sure that everything is set up correctly and continues to run smoothly.

Joanna Bookkeeping logo

Your Accountant in Oxford

Oxford Office

Joanna Bookkeeping
The Wheelhouse Angel Court
First Floor, Angel Court
81 St Clements St


01865 591952