By Gene B. Reynolds, CPA
Here’s a fact: Only 47 percent of retail start-ups are still operating after four years in business. Why? Quite often, it’s due to a lack of financial planning, little knowledge of finance, little or no experience in record-keeping, and poor credit-granting policies.
How can you keep your business from becoming a statistic? By keeping in mind four ratios to use as a guide, says CPA Gene Reynolds. “These key performance indicators will help you monitor your business on a monthly basis so you stay on a positive track.”
1. Gross Profit Ratio. This ratio is an indication of pricing strategy. The gross profit ratio reveals the average amount of money made per sales dollar. For example, if sales are $10,000 for the month and it cost you $6,000 to purchase those items you sold, then your gross profit is $4,000. Divide the gross profit by sales for the month. Your gross profit ratio is 40 percent. The recommended gross profit ratio is 50 percent for product-oriented companies.
2. Operating Expense Ratio. Operating expenses are not just merchandise purchases, they include rent, utilities, payroll, and office supplies. To calculate the operating expense ratio, divide your total operating expenses by sales. The performance target for product-oriented companies should be 25 percent to 35 percent of sales.
3. Inventory Turnover Ratio. This ratio tells a retailer how often it is necessary to replenish the stock. Too high a turnover ratio signals sales may be hurt by limited selections in the store. Too low a turnover ratio signals too much money it being tied up in inventory. Note: Retailers should turn over their inventory three or four times per year.
4. Current Ratio. The purpose of this ratio is to calculate your ability to meet short-term obligations. You begin by calculating your current assets from your balance sheet (cash, accounts receivable, inventory). Then you calculate your current liabilities (accounts payable, short-term portion of long-term debt). Divide current assets by current liabilities. Note: The recommended ratio is 2 to 1: Current assets should be double the amount of current liabilities.
- Ask your accountant to teach you how to monitor these performance indicators. The more consistent you are in hitting them, the more financially successful your business will likely be.
- To find a good accountant, your best source is your banker, who can refer you to an accountant who is experienced in your industry.
- Budget in the range of $300-$500 per month for your accountant, especially for the first three years of your business.
- Clerical and bookkeeping assistance ranges from $65/hour, to $250/hour for tax planning and business strategy consulting.
Learn more at www.gbrcpas.com
From Part 1, “PR Rules: The Playbook,” by Hope Katz Gibbs and Kathleen McCarthy. Available April 2014 at www.PR-Rules.com.