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Financial Ratios for Small Businesses

Financial Ratios for Small Businesses

Jun 1, 2023

Financial Ratios for Small Businesses

Financial ratios are tools that businesses can use to assist in achieving their goals. They help a business focus on its financial health. If used properly, financial ratios can pinpoint areas that need development. As well as highlight areas that are operating successfully in a business. Although businesses of any size can use ratios, there are some that are great for small businesses.

Gross Margin Ratio

The gross margin ratio, also known as the gross profit margin ratio, is a profitability ratio. It calculates how much profit a business makes after paying for its cost of goods sold or services. The ratio is shown as a percentage. The formula to calculate the gross margin ratio is:

Gross Margin Ratio = (Total Revenue – Cost of Goods (or Services) Sold) / Total Revenue x 100

Businesses use this ratio to measure how their direct costs relate to their revenues. The gross margin ratio shows how efficiently a business can translate its product or service into profit. Ultimately, showing the percentage of each dollar of revenue a business retains as gross profit.

Net Profit Margin Ratio

The net profit margin determines how much net profit (income) is generated from revenues received.  It accounts for the profit that remains after all business costs have been accounted for. This includes operating costs, interest, and taxes. This ratio is typically shown as a percentage and is calculated as follows:

Net Profit Margin = Net Profit / Total Revenue x 100

The higher the net profit margin, the more profit a business is generating. A low net profit margin indicates a business may be in trouble, and change may need to be implemented.

Operating Cash Flow Ratio

Operating cash flow ratio is a liquidity ratio. This ratio is like the current liability coverage ratio, both of which indicate how a business’ operations generate cash to cover debts. However, the operating cash flow ratio does not include dividends. The formula for this ratio is:

Operating Cash Flow Ratio = Net Cash Flow from Operations / Current Liabilities

A high ratio indicates that a business has sufficient cash flows to pay its obligations. A low ratio indicates the opposite. Without sufficient cash flow to pay obligations as they come due, could indicate potential solvency issues.

Accounts Receivable Turnover Ratio

The accounts receivable ratio measures how quickly a business collects its outstanding accounts receivable. Also known as the debtor’s turnover ratio, is an efficiency ratio. To calculate the ratio, divide the net sales by the average accounts receivable. The average accounts receivable is the sum of the beginning and ending accounts receivable divided by 2.

Accounts Receivable Turnover Ratio = Net Sales / Average Accounts Receivable

A higher ratio is more desirable. This means that a business’ accounts receivable collection is more frequent and efficient. Whereas a lower ratio shows a business may be more inefficient in this process.

Accounts Payable Turnover

Accounts payable turnover ratio is a liquidity ratio, that measures the average number of times a business pays its creditors. This ratio helps creditors analyze the liquidity and creditworthiness of a business. To calculate this ratio, divide the total supplier purchases by the average accounts payable. The average accounts payable is the sum of the beginning and ending accounts payable divided by 2.

Accounts Payable Turnover = Total Supplier Purchases / Average Accounts Payable

A high ratio signifies that a business promptly pays for its purchases on credit and is desirable to creditors. Whereas a low ratio indicates the opposite.

There are many different financial ratios that small businesses can use. A few of the common ratios are the gross margin, operating cash flow, and the accounts payable turnover ratios. Understanding these ratios is beneficial in achieving a business’ goals. Whether you are a beginner or an expert with financial ratios, our team is here to help!

 

Contributed by Elizabeth Partlow

What You Need to Know About DCAA and FAR Compliance

What You Need to Know About DCAA and FAR Compliance

May 8, 2023

What You Need to Know About DCAA and FAR Compliance

DCAA stands for Defense Contract Audit Agency, while FAR stands for Federal Acquisition Regulation. Both DCAA and FAR are critical components of government contracting, and compliance with them is necessary for companies that want to do business with the U.S. government.

Here are some important things you need to know about DCAA and FAR compliance:

What is DCAA Compliance?
The DCAA is responsible for auditing and evaluating government contracts and ensuring that contractors are following regulations and guidelines. To be DCAA compliant, contractors must adhere to certain accounting principles, maintain accurate and complete records, and follow proper billing procedures.

FAR Compliance
The FAR is a set of rules and guidelines that govern the acquisition process for federal agencies. The regulations cover a wide range of topics, including procurement procedures, contract administration, and ethics. Contractors must comply with the FAR to be eligible for government contracts.

DCAA Audits
The DCAA conducts audits to ensure that contractors are in compliance with government regulations. Audits can be performed on a variety of areas, including billing procedures, cost accounting, and timekeeping. Contractors should maintain accurate records and be prepared to provide documentation to support their compliance.

Compliance Requirements
Contractors must be aware of the compliance requirements for both DCAA and FAR. This includes understanding the rules and regulation, maintaining accurate records, and implementing appropriate internal controls. Failure to comply with these requirements can result in penalties, loss of contracts, and damage to a company’s reputation.

Importance of Compliance
Compliance with DCAA and FAR regulations is critical for companies that want to do business with the government. It not only ensures that contractors are following proper procedures and guidelines, but it also helps to promote transparency and accountability in government contracting.

In summary, DCAA and FAR compliance are important for companies that want to do business with the government. Contractors must be aware of the rules and regulations, maintain accurate records, and implement appropriate internal controls to ensure compliance. Failure to comply with these requirements can result in penalties, loss of contracts, and damage to a company’s reputation.

Are you a Government Contractor? Virtual CFO provides GovCon-centric strategic accounting for small businesses providing services in technology, architecture, engineering, aerospace, and project management industries. We know your pain points – let us help you relieve them – schedule a consult.

Financial Ratios

Financial Ratios

May 2, 2023

Financial Ratios

As a business owner financial data is something you have become all too familiar with. Every month you take the necessary steps to ensure your financial data is current and accurate. First, you enter the data entry into your business’ accounting system. Then you have your accountant review the books. Your accountant performs the closing process and prepares a set of financial reports, or financial statements. You take the time to complete these steps because having accurate books is not only important but necessary. However, are you utilizing your financial data to better your business? This is where financial ratios come into play. But what are financial ratios, and why are they important?

What are Financial Ratios? 

Financial ratios measure quantitative data from a business’ financial statements. The calculations for financial ratios come specifically from the balance sheet, income statement, and statement of cash flows. Comparing the ratios to industry averages and standards, and internal trends is beneficial.  In doing this, it shows insight into a business’ performance, profitability, and financial health. In lament terms, financial ratios turn your business’ data into information that helps you manage your business better.

Financial Ratio Categories

There are five major categories of financial ratios. They are:

  • Liquidity Ratios
  • Activity Ratios
  • Leverage Ratios
  • Profitability Ratios
  • Market Value Ratios

Liquidity ratios measure the ability of a business to pay off its short-term debt. The ratios help to determine if a business can use its current assets to cover its current liabilities. Common liquidity ratios are the current ratio, quick ratio, and cash ratio.

Activity ratios measure how efficiently a business is using and managing its resources to generate revenue. Often, these ratios are known as efficiency ratios. They are useful for comparing a business’ performance trending over time. Common activity ratios are accounts receivable turnover ratio, total asset turnover ratio, and days payable outstanding.

The next category of financial ratios is leverage ratios, also known as solvency ratios. These ratios measure how much debt a business uses to fund its operations. Common leverage ratios include the debt ratio, debt-equity ratio, and interest coverage ratio.

Profitability ratios measure a business’ ability to create earnings relative to its sales, operations, balance sheet assets, or shareholder’s equity. With these ratios, the higher the ratio result, the better. Examples of profitability ratios are gross profit margin, operating margin ratio, return on investments ratio, and return on asset ratio.

The last category is market value ratios. These ratios measure and analyze the current share price of a publicly held business’ stock. Examples of these ratios include earnings per share ratio, price earnings ratio, and book value per share ratio.

Why are Financial Ratios Important?

Financial ratios are useful tools for both internal and external users of a business. These ratios provide important information about a business’ performance. They help evaluate a business’ financial health. Also, ratios provide understanding of how a business is performing in comparison to its competitors. For example, management can use them to determine strengths and weaknesses of the business. Allowing for improvements to areas of weakness. As well as capitalizing on areas the business thrives in.

Financial ratios provide businesses with tools to assist in decision making. This ultimately helps a business achieve its goals. Our team is here to help if you need assistance with financial ratios!

 

Contributed by Elizabeth Partlow

 

How Accounting Plays a Role in Strategic Planning

How Accounting Plays a Role in Strategic Planning

Apr 10, 2023

How Accounting Plays a Role in Strategic Planning

As the business world changes, so too must the accountant’s role. Accounting plays a crucial role in strategic planning as it helps organizations make informed decisions based on financial data and insights. Here are a few ways accounting contributes to strategic planning:

Budgeting and Forecasting: Accounting provides historical financial data that can be used to create budgets and forecasts for the future. This helps organizations to plan and allocate resources effectively and make informed decisions about future investments.

Cost Analysis: Accounting provides insights into the costs associated with different business activities. By analyzing the costs, organizations can identify opportunities to reduce expenses and increase profitability.

Financial Reporting: Accounting generates financial statements that provide a comprehensive view of the organization’s financial performance. These reports help stakeholders, including management, investors, and creditors, make informed decisions about the organization’s future.

Performance Metrics: Accounting helps organizations track and measure key performance indicators (KPIs) that are critical to the success of the business. KPIs such as revenue, gross margin, and net income can be tracked and analyzed to determine whether the organization is meeting its strategic goals.

Risk Management: Accounting helps organizations identify and manage financial risks. By analyzing financial data, organizations can identify potential risks and develop strategies to mitigate them.

Overall, accounting plays a significant role in strategic planning by providing valuable financial data and insights that organizations can use to make informed decisions and achieve their strategic goals.

Are you a Government Contractor? Virtual CFO provides GovCon-centric strategic accounting for small businesses providing services in technology, architecture, engineering, aerospace, and project management industries. We know your pain points – let us help you relieve them – schedule a consult.

Are CPA’s Solely Tax Gurus?

Are CPA’s Solely Tax Gurus?

Apr 4, 2023

Are CPA’s Solely Tax Gurus?

Certified Public Accountants (CPA) are highly trained people, specializing in accounting. They took the time to earn a professional designation by meeting several requirements. The conditions they met include passing the CPA exam, their level of education and experience. These professional accountants are considered trusted business advisors and are well respected. Contrary to many thoughts, CPAs focus on more than just tax planning and preparation. But what exactly do CPAs do other than taxes?

What Do CPAs Do?

CPAs help business owners make informed decisions, ultimately helping them to achieve their business’ goals. Also, their level of experience and expertise allows them to provide guidance and advice. There are a few common areas of expertise that CPAs focus on. These areas include:

  • Auditing and assurance services
  • Tax preparation and consulting
  • Consulting services
  • Financial planning

The guidance and services a CPA provides can be advisory, specialty consulting, or relating to the daily operations of a business. Some examples of the day-to-day services include bookkeeping and payroll administration.

Advisory services can include assistance in recruiting future accounting staff, creating budgets, and forecasts/projections. Government contract consulting is an example of a specialty service. As a government contractor being DCAA compliant is imperative.

Benefits of Working with a CPA

As a business owner, it is very easy to get caught up in the daily. You become so focused on this, that you often push aside the financial health of your business. Working with a CPA can help you with this. They provide many benefits for a business. These benefits include:

  • Giving you more time to focus on running your business.
  • Being compliant with applicable laws (Tax, FAR, DCAA)
  • Receiving personalized business advice.
  • They can help with business growth and development.

CPAs are highly educated and experienced accounting professionals. Often, they are associated with tax planning and preparation. However, their skill set is far greater than just taxes. They possess the knowledge to provide reactive guidance when errors occur. While simultaneously using foresight to encourage growth and guidance.

Originally written by Maryney Ramirez

Updated and additional content provided by Elizabeth Partlow