There is a common misconception that an experienced finance person can look at a set of management accounts and highlight one or two numbers that indicate the health or otherwise of the business.
But this isn’t how it works – because every business is different and has different relationships between the numbers. So what is important is not the absolute values of individual numbers but to establish trends – and this is where percentages (and ratios) can really help you.
Let me give you an example – say you are running a restaurant – if you worked out wages as % of sales you could see if your rota is getting more or less efficient. Similarly if you calculated how long it was taking customers to pay (called aged debtors) you could see if you were being more or less efficient in getting in the cash.
So while 250+ page books have been written on business ratios – the two main areas you should focus on are profitability and working capital.
Let me give you an example of working capital:
For working capital there is a measure called “debtor days” or “aged receivables”. To calculate this:
- Take credit sales (ie excluding cash sales) for the past 3 months and divide by 92 to get average daily sales for the past quarter
- Find out the balance owed by customers at the end of this period
- Divide this balance by your average daily sales and bingo you get debtor days – the number of days on average your customers are taking to pay.
Credit Sales for quarter £184,000
Divide by 92 = £2,000 per day
If customers owed the business £70,000, then £70,000/£2,000 = 35 days! Ie it is taking customers on average 35 days to pay.
Your job is then clearly to manage this to the assumptions in your business model by seeing how this moves month by month – you now have a tool to see the trend.
If you would like to find out more about profit ratios then do have a look at my book “Understanding Your Business finances”. All of this of course pre-supposes that you have a proper accounting system to produce this information to calculate the ratios and percentages!…