How to assess the financial health of your company? What indicators can you use for financial analysis?
As a CFO services provider, we provide financial KPI’s for our clients. These indicators are of great use to analyze how your business is doing. They also help us find progression margins for your company.
Here are a few indicators that we often use in the financial dashboards that we build for our clients.
Net Profit Ratio
The net profit ratio is an indicator of the company profitability. It shows how much profit is generated for each money unit (1$, 1 dirham…) made in sales.
We calculate the net profit ratio by deducting all expenses (salaries, cost of goods sold, taxes, services…) from the gross profit. It shows how much profit is available once everything needed to make the product/provide the service has been paid.
It will help determine the financial health of the company. A company with a high net ratio profit is a company that succeeds in producing its products with small overall costs.
However, this ratio cannot be considered as the only one to be studied to assess the financial stability of a company. The “satisfactory” net profit ratio will vary depending on the business’ sector. We then don’t recommend using this indicator to compare companies from different industries.
Furthermore, some companies with higher operating expenses induced by their way of working (companies with debts or depreciations for example), will see their net profit ratio decrease although it doesn’t mean they are in bad financial health.
Net ratio profit is then a very useful tool for financial analyse and to pilot your company but can’t be the only one.
Account Receivable Turnover Ratio
The account receivable turnover ratio measures how efficient a company is to collect money owed to it. It evaluates how long it takes for a business to collect debts in a certain amount of time (a year or an accounting period for example).
In other words, this ratio measures how many times in a given period a company converts account receivable into cash.
Knowing this ratio is also a way of predicting the cash flow more precisely. Indeed, if a company needs a long time to collect account receivables, it is more likely that its cash flow will be lower or will take more time to be abundant.
As with any other financial ratio in financial analysis, you must use the account receivable turnover ratio with care. A high AR turnover ratio indeed means that the company is good at getting paid. But a low ratio doesn’t always mean that the company is not. It can have a credit policy which allows clients to pay later for example.
Furthermore, in certain industries, clients are paying on the spot (grocery for example). This will affect the ratio. It is then preferable to use this ratio to compare companies from the same industry.
The warehouse capacity is not a really financial analysis, but it is a very useful indicator for e-commerce or retail companies. It estimates the working warehouse capacity.
The theoretical warehouse capacity only measures the size and dimension of a business’ building. On the contrary, the working warehouse capacity estimates the real space that a company has at its disposal for storage, inventory and orders’ preparation.
It will take into consideration the weight and size of the products for example, or the space needed to prepare orders or move products.
Finding the right capacity will reduce the risk of dead stock and optimize the costs of maintaining a warehouse (rental, maintenance, inventory…).
At CTC Accounting, we use these indicators and many others for our clients. It helps us and them to run their businesses while making informed decisions.
Contact us for more information !