You don’t need to be an accountant to know whether your business is in good shape. A few simple calculations, called financial ratios, can tell you whether you can pay your bills, whether you’re carrying too much debt, and how well your business turns effort into profit.
Lenders, investors, and analysts use these same ratios to judge a company. Checking them regularly helps you spot problems early, before they become emergencies.
All you need is your balance sheet (what you own and what you owe) and your income statement (what you earned and what you spent). Your accountant can provide both.
The 5 Types of Financial Ratios
Financial ratios fall into five groups, and each one answers a different question:
| Type | The question it answers |
|---|---|
| Liquidity ratios | Can I pay my bills over the next 12 months? |
| Leverage (debt) ratios | How much of my business is financed by debt, and can I handle it? |
| Efficiency ratios | How well am I using what I have to generate sales? |
| Profitability ratios | Am I actually making money? |
| Market value ratios | What is the business worth to shareholders? (Mostly for larger or public companies.) |
Here are eight ratios worth knowing, explained simply.
1. Current Ratio: Can You Pay Your Short-Term Bills?
What it tells you: whether you have enough short-term resources (cash, receivables, inventory) to cover the bills due within the next year.
Formula: Current Ratio = Current Assets ÷ Current Liabilities
Example: $150,000 in current assets ÷ $100,000 in current liabilities = 1.5. You have $1.50 available for every $1 you owe in the short term.
What to look for: below 1 can signal cash trouble. Many businesses aim for roughly 1.5 to 2, although the right range depends on your industry. A very high ratio may mean money is sitting idle instead of being put to work.
2. Cash Ratio: Could You Pay Your Bills With Cash Alone?
What it tells you: a stricter test than the current ratio. It counts only cash and near-cash (such as short-term investments), not inventory or money customers still owe you.
Formula: Cash Ratio = (Cash + Cash Equivalents) ÷ Current Liabilities
Example: $40,000 in cash ÷ $100,000 in current liabilities = 0.4. Cash alone could cover 40% of your short-term bills.
What to look for: most healthy businesses sit below 1, and that’s normal. The point is to make sure you have a comfortable cushion for surprises.
3. Debt Service Coverage Ratio (DSCR): Can You Afford Your Loan Payments?
What it tells you: whether your business earns enough to cover its loan payments (principal and interest). Banks look at this one closely.
Formula: DSCR = Net Operating Income ÷ Total Debt Payments
Example: $125,000 in operating income ÷ $100,000 in annual loan payments = 1.25. You earn $1.25 for every $1 of debt you need to repay.
What to look for: below 1 means you’re not earning enough to cover your debt. Lenders commonly look for at least 1.2 to 1.25, and a higher ratio gives you more breathing room.
4. Asset Turnover Ratio: Are Your Assets Pulling Their Weight?
What it tells you: how many dollars of sales you generate for every dollar invested in assets such as equipment, vehicles, inventory, and property.
Formula: Asset Turnover = Net Sales ÷ Average Total Assets
Example: $500,000 in sales ÷ $250,000 in average assets = 2. Every $1 of assets brings in $2 of sales.
What to look for: compare the figure over time and against similar businesses. A falling ratio may mean you own equipment or inventory that isn’t earning its keep.
5. Accounts Receivable Turnover: How Fast Do Customers Pay You?
What it tells you: how quickly you collect money from customers who buy on credit.
Formula: A/R Turnover = Net Credit Sales ÷ Average Accounts Receivable
Example: $600,000 in credit sales ÷ $50,000 in average receivables = 12. You collect your receivables about 12 times a year, which is roughly every 30 days (365 ÷ 12).
What to look for: compare the result with your payment terms. If you invoice on 30-day terms but collect every 60 days, unpaid invoices are tying up your cash.
6. Return on Equity (ROE): What Is Your Investment Earning?
What it tells you: how much profit the business generates on the money the owners have invested in it.
Formula: ROE (%) = (Net Profit ÷ Owners’ Equity) × 100
Example: $60,000 in net profit ÷ $400,000 in equity = 15%. Each dollar invested by the owners earns 15 cents a year.
What to look for: compare ROE with what your money could earn elsewhere. Be careful, though: high debt can inflate ROE, so read it alongside your debt ratios.
7. Operating Margin: How Much of Each Sale Do You Keep?
What it tells you: how much profit you keep from each dollar of sales after paying day-to-day operating costs, before interest and taxes.
Formula: Operating Margin (%) = (Operating Income ÷ Revenue) × 100
Example: $80,000 in operating income ÷ $800,000 in revenue = 10%. You keep 10 cents from every dollar of sales.
What to look for: margins vary widely by industry, so compare yourself with similar businesses and with your own past results. A shrinking margin is an early warning that costs are rising faster than prices.
8. Earnings Per Share (EPS): Profit for Each Share
What it tells you: how much profit the company earns for each common share. This measure matters most to companies with several shareholders or outside investors.
Formula: EPS = (Net Income − Preferred Dividends) ÷ Average Number of Common Shares
Example: ($200,000 − $20,000) ÷ 90,000 shares = $2.00 per share.
What to look for: a steady rise over time. For a small owner-run business, EPS is less useful than the other ratios on this list, but it becomes important when you bring in investors or prepare to sell.
Quick Tips for Using Financial Ratios
- Track trends, not single numbers. A ratio is most useful when you compare it from quarter to quarter or year to year.
- Compare with your industry. A “good” ratio for a restaurant can look very different from one for a manufacturer.
- Look at the full picture. No single ratio tells the whole story, so read them together.
- Check regularly. Quarterly reviews help you catch problems while they’re still small.
Frequently Asked Questions
What is the best way to check my business’s financial health?
Start with a few key ratios, such as the current ratio, debt service coverage, and operating margin, and track them over time. Together they show whether you can pay your bills, handle your debt, and earn a profit.
How often should I review my financial ratios?
At least once a quarter. Monthly reviews are better if cash is tight or your business is growing quickly.
Which financial ratios do banks look at?
Banks usually focus on the debt service coverage ratio, the current ratio, and debt-to-equity, along with your overall profitability and cash flow.
Where do I find the numbers I need?
On your balance sheet and income statement. Your accountant or bookkeeping software can produce both.
Want a Deeper Look at Your Business?
Ratios are a great starting point, but they only show part of the picture. A complete analysis looks at your industry, your cash flow, your growth plans, and the story behind the numbers.
AccoClariT offers a detailed business review with personalized recommendations to help you strengthen your company’s finances, make better decisions, and grow sustainably.