1. Current Ratio
Sometimes known as the working capital ratio, this financial metric measures your business’ capacity to pay its short-term obligations, which are payables and debts due within one year, using current assets.
Current Ratio = Current Assets / Current Liabilities
A ratio of 1.0 or greater is ideal, indicating you can settle every pound or dollar owed for accounts payables, accrued expenses, and maturing debts with your existing short-term assets like cash, accounts receivables, and inventory.
2. Quick Ratio
Similar to the current ratio, it also gauges liquidity or the ability to pay off existing debts. However, they differ on the assets considered for repayment—the quick ratio only covers highly liquid assets, such as cash, marketable securities, and accounts receivable.
Dropshipping accountants calculate it as follows:
Quick Ratio = (Cash + Marketable Securities + Accounts Receivable) / Current Liabilities
Also known as the acid test ratio, it excludes inventory and prepaid expenses—the former takes time to be converted to cash, while the latter can’t be used for repayment. For most companies, the ideal metric is above 1.0.
3. Accounts Receivable Turnover
This activity ratio examines how well your business is at managing its receivables. A higher figure means you are efficient in collecting receivables and that many of your customers quickly settle their debts. Also, a high A/R turnover indicates that your company doesn’t extend credit or runs mainly on a cash basis.
A/R Turnover = Net Credit Sales / Average Accounts Receivable
A low metric isn’t good as it suggests a poor collection process, bad credit policies, or financially unsound customers. It can also mean distribution troubles since products aren’t delivered promptly, and customers delay settling their receivables, which is common with dropshippers.
4. Days Sales Outstanding
Another activity or efficiency ratio, days sales outstanding (DSO), estimates how long it takes to get paid after making a sale. While similar to A/R turnover, this metric refers to the number of days before your business can convert its outstanding receivables to cash for a given year.
DSO = (A/R / Total Credit Sales) x 365
A high DSO number shows a long waiting period to collect outstanding accounts, which can strain your cash flow as funds remain tied up in receivables. Dropshipping accountants prefer a lower figure, which means fewer days to get the money.
5. Asset Turnover Ratio
Asset turnover is an important performance metric that measures how efficiently a business utilises its resources to generate sales revenue. Accountants calculate it:
Asset Turnover Ratio = Net Sales / Average Total Assets
The higher the ratio, the more efficient your business uses its assets to generate revenue. Since it is a multiple, a figure of 2.0 means that for every £1 of assets owned, your e-commerce business makes £2 in sales. Note that it’s more meaningful to compare your metric to competitors in the same industry.
6. Debt to Equity Ratio
This financial metric shows a business’ leverage position—being highly leveraged means you have a significant amount of debt compared to industry standards and vis-à-vis your capital. Dropshipping accountants estimate it as:
D/E = Total Liabilities / Total Capital
A ratio of below one indicates that your business relies less on debt and more on capital to fund its operations. The reverse can also apply, a higher number suggests the company is more indebted. While borrowing is usual for merchants, too much dependence on debt can lead to defaults in downturns.
7. Gross Profit Margin
A critical financial metric for merchants like dropshippers, this profitability ratio shows the markup earned on products. It is calculated as:
Gross Profit Margin = (Sales – Cost of Goods Sold) / Sales
A higher ratio is preferable since it means items can be sold at higher prices than their cost for more gross profit, leaving you with enough earnings to cover operating expenses. If you have various products sold, it’s ideal to compute for each item’s margin to determine whether you need to adjust pricing.
8. Operating Profit Margin
Another key measure of profitability is the operating profit margin. Dropshipping accountants compute it as:
Operating Profit Margin = Operating Income / Sales
Operating income takes sales revenue and deducts the cost of goods sold and operating expenditures (including utilities, marketing, and administrative expenses). The operating margin shows your business’ operational efficiency in making a sale. A high margin is preferred and achievable by reining in overhead costs.
9. Net Profit Margin
The net profit margin is among the fundamental metrics that business owners should always be aware of. This ratio measures how well a company manages its overall costs to turn a profit from its revenues. Remember this formula:
Net Profit Margin = Net Profit / Sales
You can interpret it to gauge your business’ performance and efficiency in converting sales to earnings while accounting for all incurred costs in running operations.
As an example, a 0.10 or 10% margin means you keep 0.10 pence as profit for every £1 sold. For online sellers, a high number is preferred. The higher your margin, the better you are at pricing products and controlling costs.
10. Return on Assets
An important profitability measure, the return on assets (ROA) gauges how effectively a business uses its resources to generate sales. While this ratio is critical for retailers to see the relationship between inventory and sales, dropshippers will also benefit from looking at it.