7 meaningful Financial Ratios Every Startup Should Know

except having a great product, good sales, good SEO, great marketing, and so on… there is one thing that is vital to the long term growth and success of a startup: good accounting.

And yes… you may not be as versed in numbers as your accountant is. But do understand: its basic to have a working knowledge of an income statement, balance sheet, and cash flow statement.

And along with that a working knowledge of meaningful financial ratios.

And if these ratios are understood will make you a better entrepreneur, steward, company to buy and yes…investor.

Because YOU’LL know what to look for in an upcoming company.

So here are the meaningful financial ratios every startup should:

1. Working Capital Ratio

This ratio indicates whether a company has enough assets to cover its debts.

The ratio is Current assets/Current limitations.

(observe: current assets refer to those assets that can be turned into cash within a year, while current limitations refers to those debts that are due within a year)

Anything below 1 indicates negative W/C (working capital). While anything over 2 method that the company is not investing excess assets; A ratio between 1.2 and 2.0 is sufficient.

So Papa Pizza, LLC has current assets are $4,615 and current limitations are $3,003. It’s current ratio would be 1.54:

($4,615/$3,003) = 1.54

2. Debt to Equity Ratio

This is a measure of a company’s total financial leverage. It’s calculated by Total limitations/Total Assets.

(It can be applied to personal financial statements in addition as corporate ones)

David’s Glasses, LP has total limitations of $100,00 and equity is $20,000 the debt to equity ratio would be 5:

($100,000/$20,000)= 5

It depends on the industry, but a ratio of 0 to 1.5 would be considered good while anything over that…not so good!

Right now David has $5 of debt for every $1 of equity…he needs to clean up his balance sheet fast!

3. Gross Profit Margin Ratio

This shows a firms financial health to show revenue after Cost of Good Sold (COGS) are deducted.

It’s calculated as:

Revenue–COGS/Revenue=Gross Profit Margin

Let’s use a bigger company as an example this time:

DEF, LLC earned $20 million in revenue while incurring $10 million in COGS related expenses, so the gross profit margin would be %50:

$20 million-$10 million/ $20 million=.5 or %50

This method for every $1 earned it has 50 cents in gross profit…not to shabby!

4. Net Profit Margin Ratio

This shows how much the company made in OVERALL profit for every $1 it generates in sales.

It’s calculated as:

Net Income/Revenue=Net Profit

So Mikey’s Bakery earned $97,500 in net profit on $500,000 revenue so the net profit margin is %19.5:

$97,500 net profit $500,000 revenue = 0.195 or %19.5 net profit margin

For the record: I did exclude Operating Margin as a meaningful financial ratio. It is a great ratio as it is used to measure a company’s pricing strategy and operating efficiency. But just I excluded it doesn’t average you can’t use it as a meaningful financial ratio.

5. Accounts Receivable Turnover Ratio

An accounting measure used to quantify a firm’s effectiveness in extending credit in addition as collecting debts; also, its used to measure how efficiently a firm uses its assets.

It’s calculated as:

Sales/Accounts Receivable=Receivable Turnover

So Dan’s Tires, earned about $321,000 in sales has $5,000 in accounts receivables, so the receivable turnover is 64.2:

$321,000/$5,000=64.2

So this method that for every dollar invested in receivables, $64.20 comes back to the company in sales.

Good job Dan!!

6. Return on Investment Ratio

A performance measure used to estimate the efficiency of an investment to compare it against other investments.

It’s calculated as:

Gain From Investment-Cost of Investment/Cost of Investment=Return on Investment

So Hampton Media decides to shell out for a new marketing program. The new program cost $20,000 but is expected to bring in $70,000 in additional revenue:

$70,000-$20,000/$20,000=2.5 or 250%

So the company is looking for a 250% return on their investment. If they get anywhere near that…they’ll be happy campers:)

7. Return on Equity Ratio

This ratio measure’s how profitable a company is with the money shareholder’s have invested. Also known as “return on new worth” (RONW).

It’s calculated as:

Net Income/Shareholder’s Equity=Return on Equity

ABC Corp’s shareholders want to see HOW well management is using capital invested. So after looking by the books for the 2009 fiscal year they see that company made $36,547 in net income with the $200,000 they invested for a return of 18%:

$36,547/$200,000= 0.1827 or 18.27%

They like what they see.

Their money’s safe and is generating a pretty substantial return.

But what are your thoughts?

Are they any other meaningful financial ratios I missed?

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