We Sell Exceptional Businesses for Premium Values
By Telling Strategic Stories

How do financial ratios affect the value of my business?

What are some of the most common financial ratios?

Financial Ratios

Posted by David Humphrey on 2 October 2015 | Comments

Most businesses can be compared to other businesses within their industry, even those of a different size, by use of financial ratios.  Some of most common financial ratios for a closely held business include:

  • Gross profit margin
  • Profit Margin
  • Inventory Turns
  • Debt to Equity
  • Average collection period (days receivables outstanding)
  • Interest coverage
  • Working Capital
  • Acid test (quick ratio)

A business distributing $5 Million of flour and sugar annually should be able to achieve similar ratios to a $20 Million or $50 Million business in the same space.

Focusing on one metric such as days receivables outstanding can tell you about the business.  Most businesses extend credit to customers allowing the customer a certain number of days to pay the invoice.  If a review of a business’ receivables suggests the average customer is paying their bill in 45 days, Now, if 45 days is standard for most businesses in the industry, there is probably little the business can do to speed up customer payments without upsetting them.  However, if the industry typically collects receivables in 35 days, then this business is offering an extra 10 days of free financing to their customers.  This mean that 28% of their receivable or $28,000 for every $100,000 outstanding should have been collected already and available to the owner to either pay off bank financing, take early payment discounts from additional vendors or invest all of which make the business more attractive.

If a financial ratio is below average, this may be a sign of inefficiency or waste.  Beyond the additional capital required,  the longer a receivable is outstanding the more costs incurred related to staff in collecting funds, printing and mailing second statements, sending letters, calling the customer, etc.  These collection costs directly impact the bottom line and thus decreases the amount buyers are willing to pay for the business.

If you are interested in learning other ways to increase the value of your business, The Art Of Business Value Enhancement is a Must-Read!  Click here for more information.