Find out which financial ratios dropshipping accountants want you to track for better, more informed decisions when running your business venture.
10 Key Financial Ratios Dropshipping Accountants Want You to Focus On
As an entrepreneur, it’s crucial to know your business’ financial health at a glance. But for many owners, looking at the numbers on their financial statements can be a little daunting. One way to ease the confusion is to look at financial ratios.
A financial or accounting ratio measures the relationship between two or more components of a company’s financial statements. It is a tool that turns raw figures into meaningful information to help business owners gauge performance and manage operations more efficiently.
There are numerous financial ratios to track, but here are 10 of the most important metrics that dropshipping accountants from Sterlinx Global will tell you to keep your eye on.
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.
Return on Assets = Net Income / Total Assets
For dropshipping accountants, it shows the profits you can get out of every £1 of your assets. It’s better to look at how ROA changes over time—an increasing metric is preferable since it points to efficient use of resources or means you’ve made wise investments during the period.
Frequently Asked Questions about Accounting Statistics
Why are financial ratios important?
While the balance sheet, income statement, and cash flow statement are helpful, they only offer limited insight into your business. Financial ratios are much more useful in gauging performance since they come from at least two different components to reveal operational efficiencies and inefficiencies.
How can accounting statistics improve my dropshipping business?
Since they measure the relationship between various figures in your financial statements, you can quickly evaluate your business’s financial health and uncover warning signs. Then, before things become even more problematic, you can take steps to stop and improve the situation.
Can I compute these ratios myself?
Yes, you can. As an entrepreneur, it’s a fundamental skill to compute financial metrics and understand what they mean. There are many available resources you can use. But if you want to get more accurate figures, it’s best that you work with an accountant from Sterlinx Global.
The above key financial metrics are only some of the essential tools that entrepreneurs can use to evaluate their businesses’ performance and profitability at a glance. While there are many others, it’s critical that you focus on these ratios regularly to identify risks before they worsen and implement changes for a better bottom line.
Moreover, ensure you get accurate figures from experienced dropshipping accountants, such as those from Sterlinx Global.