Key financial indicators for business management

Financial ratios are one of the important tools used in corporate financial management. Financial ratios provide managers, investors, and creditors with an overview of a company’s financial situation and operational capabilities, enabling them to make sound decisions.  

To clearly understand a company’s “financial health,” managers need to master the formulas and meanings of the following basic financial ratios.

1. What are financial ratios? The role of analyzing financial ratios

1.1. What is a financial ratio?

The indicators on financial statements are metrics that reflect the status and operational capacity of a business from a financial and accounting perspective.

There are 5 characteristic groups of financial ratios for a business. Depending on the type of business and the purpose of use, managers can select necessary ratios for analysis to serve their needs.

1.2. What do financial ratios indicate?

Analyzing financial ratios helps managers identify the relationships between financial elements and measure those relationships, thereby monitoring business processes and gathering necessary information for decision-making.

Additionally, through these indicators, businesses will have a basis for evaluating the effectiveness of their corporate financial management activities. This provides a consistent basis for coordinating the company’s resources.

2. Important groups of financial ratios in a business

2.1. Liquidity Ratios

2.1.1. Current Ratio

The current ratio indicates a company’s ability to use its current assets, such as cash, inventory, or accounts receivable, to pay off its short-term liabilities.

Formula

Current Ratio = (Current Assets) / (Current Liabilities)

Meaning

• For lenders, especially short-term creditors like suppliers, the higher this ratio, the better.
• For the business, a very high ratio indicates inefficient use of cash and other current assets.
• A ratio < 1 means negative net working capital, which is an unusual factor for the company’s financial health.
• This ratio depends on the business industry.

2.1.2. Quick Ratio

The quick ratio reflects a company’s ability to pay its short-term liabilities without additional borrowing and without selling inventory.

Formula

Quick Ratio = (Current Assets – Inventory) / (Current Liabilities)

Meaning

• This ratio excludes inventory because inventory has the lowest liquidity.
• Ratio > 1 => The company can use Cash and Accounts Receivable to pay off Current Liabilities.
• Ratio < 1 => Cash and Accounts Receivable are not enough to pay off Current Liabilities => The company will have to borrow more or sell inventory.

2.1.3. Cash Ratio (Acid Ratio)

This ratio shows the relationship between assets that can be immediately and directly liquidated (like cash, marketable securities) and current liabilities. This ratio is a very strict measure of short-term debt repayment.

Formula

Cash Ratio = Cash / Current Liabilities Due

Meaning

• If this ratio is too high, it indicates that the company is holding too much cash, leading to idle capital, and should consider investing in activities with higher profit potential.
• The nature of the goods being sold should be considered when examining this ratio.

2.2. Efficiency Ratios

2.2.1. Asset Turnover Ratio

The asset turnover ratio indicates the intensity of asset utilization, meaning how much revenue is generated for every dollar of assets.

Formula

Asset Turnover Ratio = Revenue / Total Assets

Meaning

• A high ratio suggests the company is operating near full capacity and would find it difficult to expand operations without further capital investment.
• A low ratio means capital is being used inefficiently, and the company may have excess inventory, idle assets, or has borrowed too much relative to its actual needs.

2.2.2. Fixed Asset Turnover Ratio

Formula

Fixed Asset Turnover Ratio = Revenue / Total Fixed Assets

Meaning

The fixed asset turnover ratio indicates the intensity of fixed asset utilization, characteristics of the business industry, and investment characteristics.

2.2.3. Net Working Capital Turnover Ratio

The net working capital turnover ratio reflects how many times (turns) net working capital is used during a period to generate revenue.

Formula

Net Working Capital Turnover Ratio = Revenue / Current Assets – Current Liabilities

Meaning

A higher ratio indicates that the company is using its assets efficiently, generating more revenue (recovering capital quickly).

2.2.4. Inventory Turnover Ratio

The inventory turnover ratio is the number of times average inventory is sold or used during a period.

Formula

Inventory Turnover Ratio = COGS for the period / Average Inventory

Meaning

The higher the inventory turnover ratio, the better the business is considered to be, as the company invests less in inventory (saving on various related costs) while still achieving high revenue.

2.2.5. Accounts Receivable Turnover

The accounts receivable turnover ratio measures the company’s effectiveness in using trade credit (allowing customers to buy on credit) and its ability to collect debts.

Formula

Accounts Receivable Turnover = Net Credit Sales / Average Accounts Receivable

Meaning

• A low turnover may indicate the following: Poor capital utilization due to a large amount of tied-up capital? Is the company’s credit policy too lenient? Are the company’s customers facing financial difficulties?
• A high turnover: Does it reduce competitiveness, leading to lower revenue? Is the company’s debt collection effective? Are the customers’ profitability and financial conditions good?

2.2.6. Accounts Payable Turnover

This ratio monitors payables to suppliers, helping managers determine debt pressure, create budget plans, and proactively regulate cash flow during the period.

Formula

Accounts Payable Turnover = Purchases on Credit / Average Accounts Payable

Meaning

If the turnover ratio is too low, it can negatively affect the company’s credit rating.

See more: What is Financial Risk? Solutions to Prevent and Handle Risks

2.3. Financial Ratios for Assessing Profitability

2.3.1. Operating Profit Margin

This ratio indicates how much profit from production and business activities is generated for every dollar of revenue.

Formula

Operating Profit Margin = Revenue – Cost of Goods Sold – Operating Expenses / Revenue

Meaning

The higher the operating profit margin, the better. Conversely, a negative ratio indicates that the company’s operations are facing problems.

2.3.2. Net Profit Margin

The net profit margin shows how many dollars of net profit are generated for every dollar of revenue.

Formula

Net Profit Margin = Net Profit / Revenue

Meaning

• A company with a high profit margin => low expense ratio, the company manages costs well.
• Reducing the unit selling price leads to a lower profit margin, but it may increase sales volume.

2.3.3. Return on Assets (ROA)

This ratio allows for the assessment of the profitability of one dollar of business capital invested in the company’s assets, without considering the effects of corporate income tax and the origin of the business capital.

Formula

ROA = Net Profit / Total Assets

Meaning

• A high ROA indicates that the company is effectively utilizing its assets to generate profit.
• A low ROA suggests that the company’s resource management is not yet optimal.

2.3.4. Return on Equity (ROE)

The ROE ratio helps measure the efficiency of the owner’s invested capital.

ROE depends on:

• Asset utilization efficiency;
• Profit margin on revenue;
• Financial leverage.

Formula

ROE = Net Profit / Owner’s Equity

Meaning

• If ROE is less than or equal to the bank’s interest rate, it means the company’s capital is not being used effectively, and profits are insufficient to cover bank interest.
• If ROE is higher than the bank’s interest rate, it is necessary to assess whether the company has borrowed from the bank and fully exploited its competitive advantages in the market, and whether it should aim to increase the ROE ratio in the future.

2.4. Financial Ratios for Assessing Debt Structure

2.4.1. Interest Coverage Ratio

Interest payable is a fixed expense. The source for paying interest is earnings before interest and taxes (EBIT). Comparing the source for paying interest with the interest payable tells us the extent to which the company is prepared to pay interest and its ability to cover interest expenses.

Formula

Interest Coverage Ratio = EBIT / Interest Expense

Meaning

• The higher this ratio, the more effectively the company is using borrowed capital, and it indicates a high level of safety in using debt.
• If it is low, it indicates weak business performance and a limited ability to take on additional debt.

2.4.2. Debt Service Coverage Ratio

Formula

Debt Service Coverage Ratio = EBIT / Interest + Principal Due

Meaning

A low debt service coverage ratio indicates that the company will have difficulty covering or paying its current debt obligations. The company is not generating enough profit to cover its basic debt obligations.

See more: What is EBITDA? What is the difference between EBIT and EBITDA?

2.5. Financial Ratios Related to Market Value

2.5.1. Earnings Per Share (EPS)

This is the portion of a company’s profit allocated to each outstanding share of common stock. EPS is used as an indicator of a company’s profitability.

Formula

EPS = Net Profit / Number of Outstanding Shares

Meaning

• The higher the EPS, the stronger the company’s business performance, the higher the ability to pay dividends, and the stock price will tend to increase.
• If the EPS is negative, it indicates that the business is operating at a loss and facing extremely significant business difficulties.

2.5.2 P/E Ratio

P/E measures the relationship between the market price and the earnings per share. The market price is the price at which the stock is currently being traded; the earnings per share (EPS) is the portion of after-tax profit that the company distributes to common shareholders in the most recent fiscal year.

Formula

P/E = Market Price / EPS

Meaning

• P/E shows how many times the current stock price is higher than the earnings from that stock, or how much an investor has to pay for one unit of earnings.
• If the P/E ratio is negative, it is because the EPS is negative, indicating that the business is operating inefficiently and incurring losses.

3. How do financial indicators impact expansion investment decisions?

When on the verge of expansion, businesses often face the question: “Do we have the financial strength to go further?”. The answer lies within the financial indicators themselves. These are not just numbers, but a compass for businesses to weigh risks and opportunities.

Profitability (ROA, ROE) – a measure of capital strength:

• Advantage: If ROA (Return on Assets) and ROE (Return on Equity) are high, the business demonstrates efficient use of capital, capable of expanding while maintaining efficiency.
• Disadvantage: If these indicators are low, expansion will only “multiply inefficiency,” leading to the risk of compounding losses.

Debt ratio and interest coverage – the line between leverage and risk:

• Advantage: Reasonable debt helps businesses leverage financial power for rapid expansion.
• Disadvantage: A high debt-to-equity ratio or a low interest coverage ratio indicates that the business is susceptible to a debt spiral, making expansion at this time akin to “adding fuel to the fire.”

Cash flow from operating activities – the lifeblood of all decisions:

• Advantage: Positive and stable cash flow provides the business with sufficient resources to self-finance its expansion.
• Disadvantage: If cash flow is negative, even with high paper profits, expansion will create liquidity pressure and could lead to collapse.

Gross and net profit margins – indicators of competitive strength:

• Advantage: A high profit margin demonstrates a competitive advantage, and expansion will strengthen market share.
• Disadvantage: A low or declining profit margin indicates weak competitiveness; expansion will increase fixed costs without a guarantee of profit.

Financial indicators are the “safety rail.” A business should only expand when its indicators show sustainability. Ignoring them can turn expansion into a burden, or even lead to bankruptcy.

4. Analyzing financial indicators by business development stage

The same set of financial indicators is not always used to evaluate a business. Each stage of development requires focusing on different numbers, as goals and challenges constantly change.

Startup Stage – “Survival is the priority”:

• Key indicators: Cash flow from operating activities, quick ratio, burn rate.
• Meaning: A startup doesn’t need immediate profit, but it must demonstrate the ability to maintain positive cash flow or at least have enough liquidity to survive.
• Risk: Without cash flow control, a startup can easily “die young” even with significant potential revenue.

Growth Stage – “Expand, but with a firm footing”:

• Key indicators: ROA, ROE, working capital turnover, inventory turnover.
• Meaning: The business must prove that invested capital is being used effectively and is not tied up in inventory or receivables.
• Risk: Chasing revenue expansion with slow capital turnover and no profit improvement leads to cash flow strain.

Maturity Stage – “Optimize and consolidate position”:

• Key indicators: Profit margin, debt-to-equity ratio, cost ratio.
• Meaning: At this stage, the business needs to reduce costs, maintain profit margins, and reinvest selectively.
• Risk: If the profit margin decreases or fixed costs rise, the business will quickly lose its competitive edge.

Decline / Restructuring Stage – “Defend to revive”:

• Key indicators: Free cash flow, current ratio, net loss warning indicators.
• Meaning: The business needs to focus on saving cash flow, reducing its debt burden, and restructuring its operations.
• Risk: If not controlled in time, bad debt and interest payments will sink the business.

Analyzing financial indicators for each stage is like using the right “medicine” for each illness. Managers who know which stage to prioritize cash flow and which stage to focus on profit will have a suitable strategy for sustainable development.

5. An effective financial management solution for businesses with 1Office

1Office is one of the best Vietnamese business financial management software available today. The software brings high efficiency to businesses in managing revenue and expenditure in a synchronized and unified manner, helping to save time and costs in work processing.

Key features of 1Office financial management software:

• Create, edit funds: Declare the business’s funds and configure the cashier to approve receipt-payment vouchers for the fund;
• Create new receipt vouchers: This function allows users to create receipt vouchers based on the receipt type;
• Edit, delete receipt vouchers: After a new receipt voucher is created, users can edit or delete it before it is approved by the cashier.
• Easily upload documents related to receipt and payment vouchers to the software;
• Smart alerts: This function filters receipt vouchers that meet the alert’s filter conditions;
• Create, edit, delete payment vouchers: This function allows users to create new fund transfer vouchers, edit, or delete them before they are approved by the cashiers of both funds;
• Approve/Reject: This action is for cashiers who have the authority to approve/reject vouchers. When both cashiers approve, the account balances of the two funds will change accordingly.

6. Frequently Asked Questions

Which financial indicators are most important for a small business?

How often should a business review its financial indicators?

Businesses should monitor them monthly to detect fluctuations early. For important indicators like revenue, expenses, liabilities, or cash flow, many businesses even track them weekly for timely handling.

What is the difference between ROA and ROE?

ROA shows how efficiently a business uses its total assets to generate profit. ROE shows how efficiently a business uses its owner’s equity.

What should managers look at besides financial indicators?

Besides financial indicators, managers should also look at revenue by channel, sales performance, liabilities, inventory, conversion rates, work progress, and team productivity. Looking at financial figures alone is often not enough to see the root cause of a problem.

Is a high inventory turnover ratio good?

Usually, it is good, as it shows that goods are moving quickly with less capital tied up. However, if it is too high, the business should also check because it might be keeping inventory too low, which could lead to stockouts and affect sales.

Our article above has provided basic information about financial indicators, as well as their importance and how to calculate them, to help manage business finances effectively. It also offers a management solution with the 1Office financial management software to help managers thoroughly solve the problem of managing cash flow, revenue, and expenditure effectively.

For more detailed information, please see:

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