In this blog post we take a look at useful business ratios that you can use when analysing your year end or monthly management accounts. The importance of each one will vary business to business but by looking at these on a consistent basis it can give you early warning signs if problems are on the horizon.
Stock days or Work in Progress days ratio
This ratio looks at an average of how long your business is keeping items in stock, or for work in progress how long on average you are working on something before it is invoiced to the customer. The following formula is used to calculate this:
Stock / WIP Balance x Number of days in the period
Purchases in the period
So to put this into an example, you are looking at your year end accounts and they show you had a closing stock balance of £20,000 and in the year you spent £180,000 on purchases. This would mean an average stock days ratio of 40.6 days (£20,000 / £180,000 x 365 days). If you were looking at the monthly management accounts you would use purchases for the month and multiply by the number of days in the month.
Debtor days ratio
This ratio tells you the average length of time it is taking for your customers to pay you after an invoice is raised to them. It should be a key statistic you or your credit control team use to make sure it is not exceeding your payment terms. The following formula is used to calculate this:
Trade receivables balance x Number of days in the period
Sales for the period
As per the stock days ratio above, you take the sales figure for the month / year depending on what period of time you are looking at and apply the same to the number of days.
Creditor days ratio
This statistic shows on average how many days you are taking to pay your suppliers. You should always be looking to maximise payment terms with your suppliers, but of course review this alongside any early settlement discount they may be offering. The following formula is used to calculate this:
Trade payables balance x Number of days in the period
Expenses incurred with
suppliers in the period
Working capital cycle
This statistic uses all three of the above to tell you how long the business is funding itself. It’s always important to know this, but it is of particular importance when either the business is struggling with cashflow or when the business is growing quickly. This last one surprises a lot of people but many businesses fail when they are growing rapidly as they do not appreciate the effect it can have on cashflow. So to calculate your working capital cycle you do the following:
Stock days + Debtor days – Creditor days = Working capital cycle
For example, if your debtors are taking longer to pay you then the working capital cycle, and so the time the business is having to fund itself, will increase. Alternatively if you undertake an exercise to renegotiate up your payment terms with suppliers you should see the working capital cycle fall.
The above represent some key ratios to look at in your business. They should be included as part of your accounts review alongside a more detailed analytical review. At Veritons we always make sure our clients understand their numbers, and how you can use accurate numbers to tell the story behind them. If you would like to find out more on how we operate at Veritons, hit the contact us button below and arrange a free discovery meeting with us.