Every company wants consistency (as does every company’s clients), and financial controls, which are a component of the Discipline of Execution, create consistency. 

When you understand financial controls, you’ll know where the company has come from and where it’s headed.

Financials include: income statements, balance sheets, statements of cash flow and financial ratios, on a monthly, quarterly and an annual basis. 

Let’s look at the five crucial financial ratios that every business must have. 

Financial ratios are relationships determined from a company’s financial information. They are used for comparison purposes. You can use many different ratios depending on the nature of your business as well as what management’s needs are at any particular time. But generally speaking, these are the most widely used across a range of companies.

• Gross Profit Margin. Derived by dividing gross profit by sales, this is the average gross profit on each dollar of sales before operating expenses. It helps work out the profitability of each particular product that you sell.
• Net profit margin. Derived by dividing net income by sales, this is the percentage profit after operating expenses the business makes for every dollar of revenue. It’s used to show whether you’re making a profit after covering all your costs.
• Current ratio. Derived by dividing your current assets by your current liabilities, this helps measure the solvency of your business.
• Inventory turnover. Derived by dividing the cost of goods sold by your inventory, this shows how often your stock is sold and replaced in a particular period.
• Return on owner’s equity. Derived by dividing net income by owner’s equity compares the net business income to the equity invested in the business.
• Job Costing. Derived by tracking the revenue, expenses, and profit of a unique product, project, or job, including direct labor, direct materials and overhead.

Know which predictors affect your business. If you’re using the assets listed on your balance sheet to tell you the actual value of your company, you could be in for a shock when you conduct a valuation. Net worth (this is subtracting liabilities from assets) can tell you your value right now, but it won’t tell you what you’ll be worth tomorrow, next week, or next year. 

Some companies use their budgets to gauge success. A well-devised and controlled budget can tell the story of a company, including the schedule for adding new customers and how many, the number of employees on payroll, the plan for updating equipment, office space size, and more. Unfortunately, the world never entirely goes according to budget, and it seldom goes to plan.

Financials, formulas, and budgets are all important to predict and track results, but it’s the actions people take that create results, so on a regular basis, it’s essential to measure the actions that lead to the results. This is the surest way we know to predict the future of a business.

To summarize, there are five significant financial ratios that every business should be aware of, including gross profit margin, net profit margin, current ratio, return on owner’s equity, and job costing. Understanding which predictors affect your business is imperative. If you’re unsure of your company’s financial ratios, contact us today to learn how to implement effective financial controls in your organization.