Recently Xero released a whole host of business performance analysis tools. You can access these tools by clicking on Reports and then on Business Performance.
Above is a screen shot of the demo Xero company.
As a default there are eight charts, below I will explain each one in more detail and why it is useful, starting with the first four.
This is a comparison of a business’s current assets to current liabilities. If a business’s Current Ratio is exactly 1 this means that short term assets, chiefly stock, debtors and cash, is exactly equal to its immediate debts, chiefly trade creditors, tax liabilities and overdrafts.
If this number falls below 1 it means that there are more imminent debts than available assets to pay them, and your business could be in trouble.
If my business has £1,000 in the bank but owes £2,000 in Creditors, VAT and PAYE then very soon I am going to be in trouble.
For a healthy business this ratio should generally be in the 1.5 to 3 range, that is with enough ready assets to pay any debts that a falling due. Too high a figure however, and you may be using your assets inefficiently, by holding too much stock or allowing your trade debtors too much credit.
Gross Profit %
This is probably the measure that most businesses understand. It is the profit immediately after all direct costs has been taken into account divided by the turnover.
Although this is a very simple and easily understood metric it can be deceptively complicated.
Bob is a builder, who employs Wendy to help him on larger jobs.
How Bob deals with this in his accounts will directly impact on the Gross Profit %.
If he treats it as a direct cost then it will lower his Gross Profit and therefore the %, and as a general overhead it will not.
So the question is when is something a direct cost?
The answer to which is, if you did not pay the expense on this precise job or item would you be able to finish it?
So what is a good Gross Profit figure? This relies very much on what your business does, for example retail has a much tighter gross profit margin than professional services which only relies on the expert knowledge of its staff.
Debt to Equity Ratio
As the name says this is a comparison of the Debt a business has to its Equity.
So what is a Debt? This can be everything from the expected bank loans and overdrafts to money injected by you as a director. Equity is a sum of share capital and profit reserves, and so shows what a company is deemed to be worth based purely on accounting values.
So why does this matter? It is possible to have a multi-million pound business very easily, you simply sell a product very cheaply, however this leads to losses and the need for debt to support the business. The Debt to Equity Ration measures this level of Debt against the value of the business or Equity.
Bob has started a development of houses called Sunflower Valley, to finance the materials and other upfront costs he has taken out a mortgage of £500,000. His business however has traded profitably for many years and has Share Capital and Reserves totalling £250,000.
This gives him a Debt to Equity Ratio of 2, meaning he has twice as much Debt as Equity in the business.
So what is a good ratio? Again, this is very dependent on the business and its circumstances. Bob’s business may, or may not, be perfectly structured for the work he has planned.
Working Capital to Total Assets %
This metric is Net Current Assets (or Net Current Liabilities if you have a Current Ratio of less than 1) divided by Fixed and Current Assets. This measures how ‘liquid’ the company is, that is how much of the business’s assets are locked in Current assets, stock, debtors and cash, compared to its Total Assets which includes Fixed Assets, such as plant and machinery and fixtures.
If this is high this indicates that the business has sufficient Current Assets to meet its Current Liabilities, or that it operates on a very small Fixed Assets base. A low ratio may indicate a heavy investment in Fixed Assets or financial insecurity.
Bob has recently invested in digging machinery, and taken out Hire Purchase agreements to finance them. His Balance Sheet looks like this:
Fixed Assets £100,000
Current Assets £40,000
Current Liabilities £35,000
This gives him a Working Capital to Total Assets % of 3.6% £5,000 ÷ £140,000
As you can see, as with a lot of the ratios, what a good % is is very dependent on the business and its circumstances.
Next week I will go through the remaining four charts and what they mean, but don’t forget to take a look at your figures between now and then and contact us if you have any questions, and what a good result for your particular business looks like.
If you are interested in getting these figures for your business and a great, easy to use accounting package to go with it, then you can contact us by using the details and forms on the right.