Accounting and Financial Ratios: 3 Things to Know

When it comes to your small business’s accounting, you will probably need to know a thing or two about financial ratios in order to stay afloat.

When it comes to financial ratios, there are a lot of different things to know and keep in mind. We’ve talked about some of the terms to know, and about some of the ways to use financial ratios especially in light of COVID. Today, I want to talk a bit about accounting and balancing your small business’s books using financial ratios in the long run, after COVID is over. These are very useful to help you to stay afloat when issues pop up in the future.

Ok, why do want to add ratios? Aren’t 4 more than enough? I wish 4 were, but the truth is, there is more to running a business than just liquidity and solvency. We need to look at profitability and asset turnover. Profitability probably doesn’t need much explanation, but we’ve covered it. Now, what that hell is “asset turnover” and why should you care? First, asset turnover lets you know if something you own is making you money. If it is, great. If not, we probably need to find a better use for it. You should care because you have cash tied up in it. As we mentioned, liquidity and solvency are critically important so we shouldn’t have cash tied up in anything we aren’t using optimally.

Different Accounting Ratios and Financial Formulas to Know

A Business News Daily article written by Matt D’Angelo titled “Accounting Ratios and Formulas: The Basics You Need to Know” provides just that: the basics. There are five major points that D’Angelo’s article discusses:

  1. Liquidity ratios
  2. Solvency ratios 
  3. Profitability ratios 
  4. Turnover ratios 
  5. Market value ratios 

The top 2, we’re discussed in detail in our article about 4 Key Financial Ratios and COVID. Profitability was discussed in our post about Why Financial Ratios Matter. The last one is nice to know, but not as relevant to day-to-day operations. In today’s post, we’re focusing on turnover.

Fixed Asset Turnover Ratios

This is one ratio that really matters when it comes to understanding the financial aspects of various accounting strategies. Fixed Asset Turnover Ratio means looking at the net sales and the net fixed assets. Much like the turnover strategy mentioned in D’Angelo’s piece above, it is mainly about understanding where sales are coming from and how investments are operating. When it comes to accounting, this is a major financial ratio to keep in mind. AccountingTools wrote a good rundown about fixed assed turnover. It is worth looking into if you are curious about this kind of ratio. The ratio, as written by AccountingTools, is below:

Net annual sales ÷ (Gross fixed assets - Accumulated depreciation) = Fixed asset turnover ratio

Fixed Asset Accounting

When it comes to fixed assets, it can be hard to know exactly what is being asked of you. But if you are looking to perform a fixed asset turnover ratio, you might want to start with knowing why fixed assets matter in the first place. That’s where the article “Fixed Asset Accounting Skills” from Zippia comes in handy. Zippia notes that the skills of a fixed asset accountant usually involve knowing how to understand financial statements and handling the balance sheet of a company. They also work with long-term projects and handling capital assets. In other words, you need to know what is happening in the long term for a small business in order to make it work from there. This is why fixed asset turnover ratios matter, providing a wider look at your company.

Final Thoughts

If you’re looking into setting up your accounting for financial ratios, here are my final tips for you.

  1. Know the basic different ratios that are at the core of every financial plan. 
  2. Find a ratio that works for you, such as a Fixed Asset Turnover Ratio, and learn everything about it for your financial accounting work 
  3. Make sure you know the kind of accounting you need to perform in order to understand your ratios. 

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About the Author

Brian Cairns, CEO of Prostrategix Consulting. Over 25 years of business experience as a corporate executive, entrepreneur, and small business owner. For more information, please visit my LinkedIn profile

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