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Financial Ratios: Cheat Sheet for Business Owners

Updated: Jun 13





Financial statements, such as income statements and balance sheets, provide an overview of your company's financial health within a given period. 


Going beyond raw numbers, calculating financial ratios based on financial statements can help you gain a deeper understanding of business performance.


This guide talks about the financial ratios that business owners should know, why they matter, and how to calculate them.


Table of Contents 



What is a Financial Ratio?


A financial ratio is a metric used to assess your business' financial health through data.

With financial ratios, you can:


  • Reveal trends: Ratios help you identify patterns and trends in your business’ performance over time. You can find out whether your profit margins are increasing or decreasing, if your new marketing efforts are worth the investment, and so much more.

  • Identify areas for improvement: Ratios can pinpoint weaknesses in your financial performance. For example, a high debt-to-equity ratio could suggest excessive reliance on borrowed funds.

  • Benchmark your performance: Compare your key ratios against industry averages to see how your company stacks up against competitors.


Financial Ratios Using Your Income Statement


Let’s start off with a few key financial ratios you can calculate using numbers from your income statement.


Customer Acquisition Cost (CAC)


Customer acquisition cost is how much you spend to get one person to pay for your goods or services. You can calculate it by taking the total amount that your company spent on marketing and advertising (including the salaries paid for the promotion of your product or service) divided by the amount of new customers you have acquired. 

customer acquisition cost (cac)

Why is CAC An Important Financial Ratio?


Finding new customers  is crucial, but it can be daunting, difficult, and time-consuming. Through a sound understanding of CAC, you can help alleviate that stress by finding the most inexpensive yet effective ways to market your company.


Customer Lifetime Value (CLV)


Now that you know the CAC for the marketing methods that you use, it may be tempting to stop certain marketing activities altogether if they have higher CAC. 


However, if you were to focus solely on one marketing tactic and stop all of the other ones, it’d be like a new investor putting all their money into one stock. Things can go wrong. Just because one form of marketing has a higher CAC, doesn’t mean that it still isn’t a profitable form of marketing for your business. 


That is where customer lifetime value (CLV) comes in. CLV is how much value a single customer provides to your business, in total.

customer lifetime value (clv)

To calculate CLV, you take the number of years that a customer is expected to remain as a client with your company multiplied by the annual income that a customer brings to your company. 


Monthly Recurring Revenue (MRR)


As a small business owner, you need to have an idea of how much money you’re making on a monthly basis. This is called monthly recurring revenue (MRR) which is defined as an estimate of how much revenue your company typically makes every month.

 

This is especially important to keep track of if you have a subscription-based business, as it provides a clear picture of performance over time.


You can calculate MRR by adding together how much revenue you received from all customers in the last month. You can also average the calculation using 3 or 6 month periods. 

There are four types of MRR, each representing a different source of revenue.


  • Churned MRR: Lost MRR from customers opting out of their subscriptions with your service. 

  • Existing MRR: Ongoing revenue from existing customers.

  • Expansion MRR: Additional revenue from existing customers.

  • New MRR: Revenue from newly acquired customers.


Using the four types of MRR will help you find Net New MRR, a great indicator of income growth.

net new monthly recurring revenue (mrr)

Burn Rate


A company’s burn rate is a term used mostly for newer companies or startups that may need to spend more money than they make to get off the ground. More specifically, burn rate is how much cash your company uses (or “burns”) on a monthly basis.


When people talk about burn rate, they may be talking about gross burn or net burn.

gross burn and net burn rate

Gross burn relates to only the cash outflow (mostly expenses), while net burn also considers any cash inflow (mostly revenue), resulting in a lower amount of money “burned” since you’re also taking into account the money coming back in.


Gross Profit Margin


You may have been confused about the term ‘gross profit margin’ in the past, since it is often used interchangeably with ‘gross profit’. 


The difference? Gross profit margin is a ratio, while gross profit is simply a dollar amount. 

Gross profit is the amount of money your company keeps after considering all costs. 


Company’s revenue − cost of goods sold = Gross profit. Gross margin, on the other hand, is a ratio that you can compare with other companies in your industry. It tells you how well your business operations are performing and can be calculated in two steps. 

gross profit margin

The Business Development Bank of Canada states that a gross profit margin anywhere from 50-70% is generally good for many businesses. However, gross profit and gross margin vary tremendously between industries, so it is important to do your own research regarding what ideal values would be for your unique business.



Financial Ratios Using Your Balance Sheet


Working Capital


Think of working capital as the engine of your company. All your company’s cash, equipment, supplies and other resources are used to power this engine.


Working capital is what you have in current assets after subtracting your current liabilities. It is a collection of everything that is helpful to your company after considering any debt and other liabilities that would decrease the value of your company’s resources. 

working capital

Evidently, you want a higher working capital, as it can demonstrate to investors and lenders that you are able to pay off short-term debt. 


Runway


The amount of time your business can operate before running out of money is referred to as runway.

runway

Burn rate and runway work together to provide a  better understanding of the funds they have and how long the company will stay alive before reaching profitability.


Debt to Equity


Debt-to-equity is calculated as total liabilities divided by shareholders’ equity. It shows you how much debt you have compared to the sum of your retained earnings and any money that has been invested into the company.

debt to equity ratio

A lower debt-to-equity (D/E) ratio is generally considered better because it indicates that a company is less reliant on borrowing to finance its operations. This suggests a more stable financial structure and potentially lower risk for investors. 


However, it's important to note that the ideal D/E ratio can vary by industry. Some industries, like real estate, often operate with higher debt levels because of the capital-intensive nature of their businesses. Therefore, when evaluating a company's D/E ratio, it should be compared to industry norms and specific business circumstances.


In summary, while a lower D/E ratio is generally seen as positive, it's essential to consider the industry context and the company's specific situation.


Conclusion


Financial ratios turn the raw data from your financial statements into actionable insights. 

By understanding these ratios and how to use them, you can make smarter decisions about how to allocate resources, set prices, budget effectively, and plan for the future growth of your business. 


We recommend using a cloud-based accounting solution to keep track of all your financial information and ratios seamlessly. 


You can start accounting for free today with ReInvestWealth’s 30-day free trial!

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