## Calculating Profitability Ratios

Profitability Ratios evaluate the financial viability of a business and provide a measure of comparison and performance to the industry in which the business falls.

These ratios include:

**NET MARGIN RATIO**

The Net Margin Ratio measures how much a company earns after taxes relative to its sales. The formula is as follows:

**Net Profit Margin = Net Profit/Revenue**

A higher net profit margin tells the investor the business is more efficient and flexible and capable of taking on new opportunities.

**OPERATING PROFIT MARGIN RATIO**

The Operating Profit Margin Ratio measures earnings before interest and taxes (EBIT). The formula is as follows:

**Operating Profit Margin = Operating Income/Net Sales**

This gives the investor an idea of whether they want to invest in a company and bankers an idea of whether they should consider providing additional debt financing.

**RETURN ON ASSETS RATIO**

The Return on Assets Ratio measures how well management is using the company’s resources. The formula is as follows:

**Return on Assets = Net Income/Total Assets**

This will vary widely by industry but it gives investors an idea of how well the company is leveraging its assets to benefit the investment return.

**RETURN ON EQUITY RATIO**

The Return on Equity Ratio measures how well the business as an investment is doing relative to the investment by its shareholders. The formula is as follows:

**Return on Equity = Net Income/Shareholder’s Equity**

This helps investors understand how much money the company is earning for each invested dollar and may be a good predictor of return for their investment.

While these formulas are straightforward, I have created a spreadsheet calculator for readers to use an explore. If you’re interested, you can download the Efficiency Ratio Calculator using the button below. If you would like to learn more about Financial Ratios and how they may be used, read the post, Financial Ratio Analysis and the Entrepreneur.

A few notes on this calculator:

- This calculator is an example and is for use as is. It is not supported in any way. It is not intended to be a tool to use without customization based on the specifics of an entrepreneurial venture and its unique financial statements.
- This calculator is only an example to give the reader an idea of how such a tool can be developed. The numbers within are not based on a real business. I compiled this as an offshoot of work in a graduate class, but I have created developed similar models for entrepreneurial ventures. Each business venture is different, and so is the ratios used and considered for that enterprise.
- Financial Ratio calculations are done annually using actual numbers. This model can be used in that way. It can also be used to calculate and review ratios monthly. Monthly numbers would allow the reader to track improvements over time.
- All of the “Bold Blue” text areas can be changed to demonstrate how the interactivity might work. No other data can be changed.
- Formulas can be seen in each of the cells (mouse over it), but only the values in the “Bold Blue” text area can be changed.
- By downloading you acknowledge this is for personal use only. It is not to be sold or distributed in any way.

Reference

Rogers, S. (2014). *Entrepreneurial Finance: Finance and Business Strategies for the Serious Entrepreneur.* New York: McGraw Hill Education.

David Harkins is a serial entrepreneur with significant experience in branding, strategy, licensing and marketing.

In his spare time, he consults, coaches, speaks, writes, hikes, explores, and creates art. Although, not necessarily in that order.

Connect with him on social media below:

## Calculating Efficiency Ratios

Efficiency Ratios provide additional insights into business operations. These are useful in helping an investor or lender spot key problem areas related to inventory management, cash flow, and collections.

These ratios include:

**INVENTORY TURN-OVER RATIO **

The Inventory Turn-Over Ratio measures how long it takes for inventory to be sold and replaced during a period (typically a year.) The formula is as follows:

**Inventory Turnover = Cost of Goods Sold/Average Inventory***

The longer inventory sits on the shelf, the more it costs the company because gross profit is not realized from the sale. Sales and inventory management are key measures for investors.

**Average Inventory = (Beginning Inventory+Ending Inventory)/2*

**AVERAGE COLLECTION PERIOD RATIO**

The Average Collection Period Ratio measures the average number of days customers take to pay for products or services. The formula is as follows:

**Average Collection = Account Balances for the Year/Net Sales for the Year**

A short average collection period compared to industry standards is preferred by investors.

While these formulas are straightforward, I have created a spreadsheet calculator for readers to use an explore. If you’re interested, you can download the Efficiency Ratio Calculator using the button below. If you would like to learn more about Financial Ratios and how they may be used, read the post, Financial Ratio Analysis and the Entrepreneur.

A few notes on this calculator:

- This calculator is an example and is for use as is. It is not supported in any way. It is not intended to be a tool to use without customization based on the specifics of an entrepreneurial venture and its unique financial statements.
- This calculator is only an example to give the reader an idea of how such a tool can be developed. The numbers within are not based on a real business. I compiled this as an offshoot of work in a graduate class, but I have created developed similar models for entrepreneurial ventures. Each business venture is different, and so is the ratios used and considered for that enterprise.
- Financial Ratio calculations are done annually using actual numbers. This model can be used in that way. It can also be used to calculate and review ratios monthly. Monthly numbers would allow the reader to track improvements over time.
- All of the “Bold Blue” text areas can be changed to demonstrate how the interactivity might work. No other data can be changed.
- Formulas can be seen in each of the cells (mouse over it), but only the values in the “Bold Blue” text area can be changed.
- By downloading you acknowledge this is for personal use only. It is not to be sold or distributed in any way.

Reference

Rogers, S. (2014). *Entrepreneurial Finance: Finance and Business Strategies for the Serious Entrepreneur.* New York: McGraw Hill Education.

David Harkins is a serial entrepreneur with significant experience in branding, strategy, licensing and marketing.

In his spare time, he consults, coaches, speaks, writes, hikes, explores, and creates art. Although, not necessarily in that order.

Connect with him on social media below:

## Calculating Liquidity Ratios

Liquidity Ratios measure the amount of liquidity the business has to cover its debt and provides a high-level overview of financial health.

These ratios include:

**CURRENT RATIO (Also known as the Working Capital Ratio)**

The Current Ratio measures the company’s ability to generate cash to meet short-term financial commitments. The formula is as follows:

**Current Ratio =Current/Current Liabilities**

The current ratio serves as an early warning sign of the business possible cash flow issues for investors and lenders.

**QUICK RATIO (Also known as the “Acid Test”)**

The Quick Ratio measures the businesses ability to access cash quickly for immediate demands. The formula is as follows:

**Quick Ratio = Current Assets – Inventories/Current Liabilities**

A ratio of 1.0 or greater is acceptable, but it is industry dependent. Generally speaking, investors prefer a higher quick ratio.

While these formulas are straightforward, I have created a spreadsheet calculator for readers to use an explore. If you’re interested, you can download the Liquidity Ratio Calculator using the button below. If you would like to learn more about Financial Ratios and how they may be used, read the post, Financial Ratio Analysis and the Entrepreneur.

A few notes on this calculator:

- This calculator is an example and is for use as is. It is not supported in any way. It is not intended to be a tool to use without customization based on the specifics of an entrepreneurial venture and its unique financial statements.
- This calculator is only an example to give the reader an idea of how such a tool can be developed. The numbers within are not based on a real business. I compiled this as an offshoot of work in a graduate class, but I have created developed similar models for entrepreneurial ventures. Each business venture is different, and so is the ratios used and considered for that enterprise.
- Financial Ratio calculations are done annually using actual numbers. This model can be used in that way. It can also be used to calculate and review ratios monthly. Monthly numbers would allow the reader to track improvements over time.
- All of the “Bold Blue” text areas can be changed to demonstrate how the interactivity might work. No other data can be changed.
- Formulas can be seen in each of the cells (mouse over it), but only the values in the “Bold Blue” text area can be changed.
- By downloading you acknowledge this is for personal use only. It is not to be sold or distributed in any way.

Reference

Rogers, S. (2014). *Entrepreneurial Finance: Finance and Business Strategies for the Serious Entrepreneur.* New York: McGraw Hill Education.

David Harkins is a serial entrepreneur with significant experience in branding, strategy, licensing and marketing.

In his spare time, he consults, coaches, speaks, writes, hikes, explores, and creates art. Although, not necessarily in that order.

Connect with him on social media below: