Understanding financial ratios is an important part of managing company performance. Large companies have had a long tradition of using ratios as a way to monitor and manage business performance. Small companies have tended to not use ratios because of the work involved in doing the calculations. That is all changing with tools like the Corelytics Financial Dashboard that not only make it easier to calculate, they also provide predictive analytics to show your trends and future business direction.
AR Days – sometimes referred to as DOR or “days of receivables,” this ratio tells you how many average days of revenue are tied up in receivables. If all of your clients took exactly 30 days to pay their bills, you would have 30 days of revenue held in receivables. If you require your clients to pay in 2 weeks from the receipt of an invoice, the AR Days ratio will move closer to 15. And if you set up clients to pay a fixed monthly fee at the first of the month you actually start to move closer to zero days in AR.
When AR Days increases, more of your cash is getting tied up in AR and not available to pay bills and make payroll. A more subtle problem occurs when AR Days grows: the risk of lost revenue increases. In general, customers become less likely to pay the bills the longer they delay in making payments. This is usually because there is an unresolved issue or because the client’s business is in trouble. In any case, the problem will grow if given more time.
Debt-to-Assets – the ratio of all assets to all liabilities. This shows how much of your business is being supported by debt. When this ratio gets smaller, it means you have less assets and/or more debt, which means more debt is being used to support the company. If debt is growing faster than revenues it means the business may not be sustainable in the long term. But this can be a healthy sign if debt is increasing to support new investments in tools or people with the expectation that revenues will increase and the debt will decrease over time.
Quick Ratio – the ratio of current assets to current liabilities. This generally shows how well short term operations are funding the overall costs of doing business. When this ratio gets smaller, it means you are incurring more debt to finance operations. It is reasonable for this ratio to move up and down more than the Debt to Asset Ratio, but if it is showing a continuing trend downward it could indicate that the business is headed for major problem.
Ultimately, as a business owner you need to understand how resources are being used in your business over time and calculate the change in ratios monthly, quarterly and annually. The Corelytics financial dashboard saves you time in calculating ratios and trends, and more ratios and key performance indicators will soon be added. However you choose to do this, just make sure you monitor your ratios; they tell you a lot about how your business is performing.