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in ﬁnancial management textbooks. Experts will almost always agree on the importance of following
changes in a ratio over time, and on the wide variations of standards depending on the type of
business. PROFITABILITY RATIOS Most business plans include some standard business ratios.
• Gross Margin: sales minus cost of sales, expressed as a percentage of sales. • Net Proﬁt Margin: net proﬁt divided by sales, as a percentage. • Return on Assets: net proﬁt divided by the total assets. • Return on Equity: also return on investment (ROI). This ratio divides net proﬁt by net worth. HURDLE: THE BOOK 17.4 ON BUSINESS PLANNING Return on Equity or Return on Investment (ROI) is probably the most important of these ratios. A
business is an investment and it should yield proﬁts comparable to alternative investments, unless
there is additional compensation (such as salaries for the owners). In theory, at least, if ROI is low, you
should sell the business and put your investment money to better use.
Return on Assets and the Net Proﬁt Margin provide a good basis for comparison between your
company and the rest of the industry. They are also good indicators of company performance from
year to year. ACTIVITY RATIOS Activity ratios focus on ﬁnancial performance.
These ratios are generally used to compare a company’s performance to the average for its
industry. Levels of acceptability tend to vary widely between different industries. For example, large
manufacturing companies might have a very low assets turnover, but retail stores should have a high
• Accounts Receivable Turnover: sales on credit divided by accounts receivable. This is a measure
of how well your business collects its debts. • Collection Days: accounts receivable multiplied by 360, then divided by annual credit sales is
another measure of debt collection and value of receivables. Generally, 30 days is exceptionally
good, 60 days is bothersome, and 90 days or more is a real problem. This varies by industry. • Inventory Turnover: cost of sales di...
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