Financial Ratios Explained

A practical guide to the financial ratios tracked in the KPI Dashboard tab, what they mean, and when to worry.

Liquidity Ratios

These answer: "Can we pay our bills?"

Current Ratio

Current Ratio = Total Current Assets ÷ Total Current Liabilities

What it measures: Your ability to pay obligations due within 12 months using assets that can be converted to cash within 12 months.

In the sample data: Current ratio is 3.32 by December, showing strong liquidity growth throughout the year (started at 2.41 in January).

When to worry: A declining current ratio, especially below 1.5, means you might struggle to pay bills on time. Consider slowing spending or accelerating collections.

Quick Ratio (Acid Test)

Quick Ratio = (Current Assets - Inventory) ÷ Current Liabilities

Why exclude inventory? Inventory can't always be sold quickly at full value. The quick ratio shows what you could pay if you needed cash *tomorrow*.

In the sample data: Quick ratio closely tracks current ratio because inventory is a small portion of assets. If you're a product business with significant inventory, the gap between these two ratios matters more.

Profitability Ratios

These answer: "Are we making money efficiently?"

Gross Margin

Gross Margin = Gross Profit ÷ Revenue × 100

Measures pricing effectiveness and cost control on direct costs.

Industry benchmarks:

• Professional services: 60-80%
• Software/SaaS: 70-90%
• E-commerce: 30-50%
• Manufacturing: 25-45%
• Retail: 20-40%

In the sample data: ~66% — healthy for a service/product hybrid business.

Net Margin

Net Margin = Net Income ÷ Revenue × 100

The true bottom-line profitability after ALL costs.

Healthy ranges for small businesses:

• 10-20% — most service businesses
• 5-10% — product businesses with thin margins
• 20%+ — exceptional (or you might be underpaying yourself)

In the sample data: 10-17% range, averaging ~13%.

Operating Margin

Operating Margin = Operating Income ÷ Revenue × 100

Profitability from core operations, before interest and taxes. This is the purest measure of business efficiency because it excludes financing decisions and tax situations.

Efficiency Ratios

These answer: "How well are we using our resources?"

Accounts Receivable Days (Days Sales Outstanding)

AR Days = (Accounts Receivable ÷ Monthly Revenue) × 30

What it measures: Average number of days between invoicing and getting paid.

In the sample data: ~34 days on average. Slightly above the 30-day target but manageable.

How to improve:

• Shorten payment terms (Net 15 instead of Net 30)
• Offer early payment discounts (2/10 Net 30)
• Send invoices immediately upon delivery
• Follow up promptly on overdue accounts

Monthly Burn Rate

Burn Rate = Total Operating Expenses (monthly)

What it measures: How much cash you spend per month on operations, regardless of revenue.

Why it matters: If revenue drops to zero tomorrow, burn rate tells you how fast your cash reserves deplete.

Months of Runway = Cash Balance ÷ Monthly Burn Rate

In the sample data: December burn rate = $41,750. Cash balance = $112,173. Runway = 2.7 months with zero revenue. This is a healthy buffer for an established business.

Growth Metrics

Revenue Growth (Month-over-Month)

MoM Growth = (This Month Revenue - Last Month Revenue) ÷ Last Month Revenue × 100

Target for small businesses: 3-5% month-over-month (43-80% annualized).

In the sample data: Volatile, ranging from -10.8% to +13.8%. This is common for service businesses where project timing creates lumpy revenue. Look at the trailing 3-month average for a smoother signal.

Recurring Revenue Percentage

Recurring % = Recurring Revenue ÷ Total Revenue × 100

Why it matters: Recurring revenue is predictable, reducing cash flow anxiety. Investors value it highly.

Targets:

• <10% — Entirely project-based (high risk)
• 10-30% — Transitioning toward stability
• 30-50% — Healthy mix
• 50%+ — Highly predictable business

In the sample data: 17-20%, indicating room to grow recurring revenue streams.

Using Ratios for Decision-Making

The "Health Check" Matrix

Run this monthly:

Ratio Trends Matter More Than Absolutes

A current ratio of 1.8 that's been improving for 6 months is better than a 2.5 that's been declining. Always look at the direction, not just the snapshot.

Comparing Yourself to Industry

Don't compare a consulting firm's margins to a retailer's. Use these resources for benchmarks:

• Industry association reports
• Small Business Administration data
• Accounting firm annual surveys

Formulas Quick Reference (for the KPI Dashboard tab)

Reading Your P&L Statement

A plain-language guide to understanding your Profit & Loss statement and using it to make better business decisions.

What Is a P&L Statement?

A Profit & Loss statement (also called an Income Statement) shows how much money your business earned, how much it spent, and what's left over — for a specific time period.

Think of it as an answer to: "Did we make money this month?"

The Structure (Top to Bottom)

Revenue (money coming in)
- Cost of Goods Sold (direct costs to deliver your product/service)
= Gross Profit (revenue minus direct costs)
- Operating Expenses (overhead: rent, salaries, marketing, etc.)
= Operating Income (profit from core business operations)
- Interest & Taxes
= Net Income (the true bottom line)

Each level tells you something different:

Key Margins to Watch

Gross Margin = Gross Profit ÷ Revenue

What it means: For every dollar of revenue, how much is left after paying for the thing you sold?

• 70%+ gross margin — typical for services/software businesses
• 40-60% — typical for product businesses
• 20-40% — typical for retail/manufacturing

In the sample data, gross margin is ~66%. This means for every $1 earned, $0.34 goes to direct costs and $0.66 is available to cover overhead and profit.

Red flag: If gross margin is declining month over month, your costs are rising faster than your prices. Either raise prices or find cheaper suppliers.

Operating Margin = Operating Income ÷ Revenue

What it means: After paying for everything needed to run the business (rent, people, marketing), what's left?

• 20%+ — excellent for a small business
• 10-20% — healthy
• <10% — tight; small revenue drops could push you negative

In the sample data, operating margin ranges from 14% to 23%, averaging around 18%.

Net Margin = Net Income ÷ Revenue

What it means: The true percentage of revenue that becomes profit.

After interest payments and tax provisions, the sample business keeps 10-17% of revenue as profit.

Month-over-Month Trends to Track

Revenue trends

Look at the "Total Revenue" row across months:

• Is it generally going up? (Growth)
• Is it flat? (Stagnation — investigate)
• Is it seasonal? (Normal for many businesses — plan for lean months)

The sample shows revenue ranging from $71K to $96K, with a general upward trend.

Expense creep

Compare Total Operating Expenses month-over-month:

• Are expenses growing faster than revenue? That's a problem.
• Calculate: OpEx Growth Rate vs Revenue Growth Rate
• If OpEx consistently outgrows revenue, margins shrink and eventually you're unprofitable.

One-time vs. recurring expenses

Scan the expense tracker for unusual spikes. In the sample:

• March and September show equipment purchases (capital expenditures)
• These are investing activities, not operating expenses
• Make sure capital purchases go to the Balance Sheet, not the P&L

Using the P&L for Decisions

"Can we afford to hire?"

1. Look at Operating Income — that's your surplus after current expenses

2. A new hire costs salary + benefits + taxes (typically 1.25-1.4x the base salary)

3. If Operating Income > (Annual salary × 1.3 ÷ 12), you can afford it without going negative

Example from sample: December Operating Income = $15,250/month. A hire at $60K/year = $5,000/month (×1.3 = $6,500/month). Yes, affordable.

"Should we increase marketing spend?"

1. Calculate your current marketing ROI: New Revenue Attributable to Marketing ÷ Marketing Spend

2. If ROI > 3x, increasing spend is usually worthwhile

3. Model it: add the proposed increase to Marketing & Advertising, see how it affects Operating Income

4. Make sure it doesn't push you cash-negative (check Cash Flow tab)

"Are we pricing correctly?"

1. If Gross Margin is declining while Revenue grows, you're likely discounting too much

2. If Gross Margin is stable but Operating Margin is declining, overhead is the problem (not pricing)

3. Target: Gross Margin should cover all operating expenses with 10%+ left over

Common P&L Mistakes

1. Mixing capital and operating expenses — A new laptop is an asset (Balance Sheet), not an expense (P&L). Depreciation is the P&L impact.

2. Forgetting owner compensation — If you're not paying yourself a market salary, your true profit is lower than it appears.

3. Ignoring seasonality — Don't panic at a bad month if your business is naturally cyclical. Look at trailing 3-month or 12-month averages.

4. Comparing to the wrong benchmark — A 15% net margin is great for a services business but terrible for a SaaS company charging recurring fees. Know your industry.

Action Items From Your P&L

After reviewing each month's P&L, ask:

• [ ] Is revenue growing at least as fast as expenses?
• [ ] Is gross margin stable or improving?
• [ ] Are there any expense categories growing faster than 10% per month?
• [ ] Does net income cover my minimum living needs (for owner-operators)?
• [ ] Am I building a cash reserve (check Cash Flow tab)?

If any answer is "no," investigate before the next month closes.