The Financial Ratios Used to Assess Business Risk

Running a business in Australia can be incredibly lucrative as it is tough. For this reason, taking a business risk you haven’t adequately calculated or assessed can make a massive impact on your success and potentially jeopardise your financial stability. It can even lead to bankruptcy if you aren’t careful, putting all your hard work into the gutter.


It’s impossible to avoid risks in a business. Apart from the financial risks, you’ll also have operational, compliance, and global risks you’ll have to keep in mind. Luckily, you can take care of the financial aspect by working with an eCommerce accountant specialising in your industry, ensuring you make a wise, well-informed decision that will move you forward.


All About Financial Ratios


Accountants help your business succeed by carefully studying your financial situation and assessing the possible hazards and risks you’ll need to avoid. They do this by using financial ratios, which are measurement tools that offer information about your business’s financial health. The percentages help the accountant or bookkeeper scrutinise your performance in your location or industry.


Financial ratios are incredibly helpful in providing details of inventory, debts, and receivables so that you’re aware of the losses you experience through these. Here are the financial ratios that many Gold Coast accountants use to measure business risks:


1. Debt-to-Capital Ratio


Accountants and bookkeepers use this ratio to understand your business’s financial standing. They calculate the percentage by comparing long-term and short-term debts with your business’s total capital from shareholder’s equity and debt financing. It then pinpoints your capacity to repay the debt. The formula they use is the following:


Debt-to-Capital Ratio = Long-Term Debt + Short-Term Debt / Total Debt + Equity


A lower ratio demonstrates that your business doesn’t depend on your debts, and you can manage your running expenses. However, a higher ratio indicates that your business has borrowed a lot of money to survive, leaving you at a higher risk of financial precariousness.


2. Debt-to-Equity Ratio


This ratio offers insight into your business’s capability of repaying your debts by using a direct approach. The ratio compares debt financing with equity financing through this formula:


Debt-to-Equity Ratio = Long-Term Liabilities + Current Liabilities / Equity


The current liabilities are short-term obligations of your business, like salaries and taxes. A lower ratio means that your company is in good control of your finances, and you aren’t completely dependent on loans to survive. It also means you can weather small financial troubles without having to borrow funds. Likewise, a higher ratio means you need a lot of debt to keep running, which can interfere with your ability to get funds from moneylenders.


3. Current or Liquidity Ratio


Bookkeepers use the liquidity ratio to identify your business’s ability to pay off your short-term liabilities that are due within the following year. It tells you about your short-term liquidity based on your current assets, which can be liquidated quickly, and outstanding liabilities. The formula used is the following:


Current Ratio = Current Assets/ Current Liabilities


If the ratio is more than one, it means you are in a secure position to pay your short-term debts. If it is less than one, then you may not be able to repay them.


4. Quick Ratio


A fast way to calculate your short-term risks is the quick ratio, although this does not include inventory in current assets since it can take a while to liquidate inventory. The formula is the following:


Quick Ratio = Current Assets – Inventory / Current Liabilities


5. Solvency Ratio


Lastly, the solvency ratio plays a huge part in the tasks carried out by the bookkeeper or accountant. It identifies your business’s long-term sustainability and determines if you can manage your liabilities. The following formula is used to calculate this ratio:


Solvency Ratio = Net Profit Tax + Depreciation / Current Liabilities + Long-Term Liabilities


A lower amount means your business cannot pay off its debt in the long run. The number should be above 20 per cent to achieve a healthy financial status, although this may change depending on the industry.


Conclusion


These financial ratios are beneficial for looking after your business’s financial health. Working with a small business accountant can help you make well-informed business risks that can bring loads of revenue and success.


The ECommerce Accountant is a team of accountants for online businesses that can take care of all the financial aspects of your business so you can focus on what you do best. We can help your online business grow through our bookkeeping and accounting services specially tailored to eCommerce. Book a free 30-minute discovery call with us today!

7 views0 comments