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To interpret financial ratios for a Canadian business, compare each one with the same ratio last year and with businesses like yours, never with a magic number. A current ratio of 1.5 can be comfortable in one trade and thin in another. The ratios themselves are simple division. The judgement sits in what you compare them with.
Which ratios are worth calculating first?
Start with four questions. Can we pay what’s due soon? Do we make money on what we sell? Are we carrying too much debt? Is cash stuck in stock or unpaid invoices? Each has one or two ratios, and that’s plenty for a small business.
Here’s one made-up business to work with: $500,000 of sales, $300,000 of cost of sales, $40,000 of net profit, $90,000 of current assets (of which $30,000 is stock and $45,000 is unpaid invoices), $60,000 of current liabilities, $120,000 of total liabilities and $80,000 of owner’s equity. None of it is real. It’s only there so the maths has something to grab.
| Ratio | How to work it out | Our example |
|---|---|---|
| Current ratio | Current assets / current liabilities | 1.5 |
| Quick ratio | (Current assets minus stock) / current liabilities | 1.0 |
| Gross margin | (Sales minus cost of sales) / sales | 40% |
| Net margin | Net profit / sales | 8% |
| Debt to equity | Total liabilities / equity | 1.5 |
| Days to collect | Unpaid invoices / sales x 365 | about 33 days |
| Stock turnover | Cost of sales / stock | 10 times a year |
What do the liquidity numbers tell you?
They tell you whether the bills due in the next twelve months are covered by what you own that turns into cash in the same period. In our example, $90,000 against $60,000 gives 1.5. Strip out stock, which may take months to sell, and you get 1.0. Assets just cover liabilities.
Is that bad? It depends. A shop whose stock sells in five weeks can live with it. A firm whose customers pay in 90 days can’t. So read the quick ratio next to the days to collect, not alone.
What happens when customers pay late?
Here’s where the days-to-collect number earns its keep. In our example, $45,000 of unpaid invoices on $500,000 of sales is about 33 days. Now say customers stretch to 60 days. At that pace the business would be owed about $82,200 ($500,000 times 60, divided by 365), roughly $37,200 more than before. Nothing about the product or the prices changed, yet that cash is sitting in other people’s accounts. A business that can’t absorb that swing ends up borrowing to cover payroll, and the quick ratio is the first number to show it.
Stock works the same way. Cost of sales of $300,000 over $30,000 of stock is ten turns a year, or one full cycle about every five weeks (365 divided by 10 is 36.5 days). Slow that down and cash gets tied up on the shelf.
How do you read margins?
Gross margin says what’s left after the direct cost of the product. Net margin says what’s left after everything. Our example keeps 40 cents of each sales dollar at the gross level and 8 cents at the end, so 32 cents went on overheads, wages, interest and tax. The profit margin calculator reproduces the 40% from $300,000 of cost and $500,000 of sales.
Watch the trend. A margin that slides two points a year is a warning even when it still looks healthy. Use the percentage calculator to check how one figure compares with another.
What about debt and returns?
Debt to equity of 1.5 means the business owes $1.50 for every dollar the owners have in it. Lenders read that closely, but they also look at whether profit covers the interest. Divide profit before interest and tax by the interest bill. If that’s under about 1, the business isn’t earning enough to pay its lender, which is true whatever the industry.
For return, our example earns $40,000 on $200,000 of assets, 20% a year. The ROI calculator takes the same inputs. It ignores tax and fees, so it flatters the result.
How often should you look at them?
Quarterly is a fair rhythm for most small businesses, and monthly if cash is tight. Pick the same handful each time and put them in one row of a spreadsheet, so the trend jumps out. Think of Raj, who runs a small print shop in Kitchener. He doesn’t chase twenty ratios. He watches two: days to collect and gross margin. When either slips, he phones customers or checks his paper costs that week, not at tax time.
Where do ratios mislead?
Three places. Year-end snapshots hide swings, since a business may look flush on 31 December and be short by February. Different accounting choices, such as how stock is valued, change the numbers without changing reality. And averages from other businesses only help if they’re your kind of business, the same size and in the same place.
This page gives no target numbers. Rules of thumb you see online (a good current ratio, a cap on debt) are often quoted without a source, and we haven’t confirmed them. If you want a comparison, Statistics Canada publishes financial ratios by industry for incorporated enterprises. They’re aggregates, so they show a rough range, not a pass mark.
Where this information comes from
The formulas are standard accounting definitions. The business in the examples is invented, and the results come from simple division and from our own calculators. The pointer to industry ratios is from Statistics Canada‘s financial and taxation statistics for enterprises. No figure in the examples comes from any government body, and this site has no link with one.
Frequently asked questions
What is a good current ratio?
It depends on the industry and how fast you collect cash. We give no target, so compare with your own past years and with similar businesses.
What is the difference between the current and quick ratio?
The quick ratio takes stock out of current assets first, because stock can take a while to turn into cash.
What is the difference between gross and net margin?
Gross margin only deducts the direct cost of what you sell. Net margin deducts every cost, including overheads and interest.
How often should I calculate ratios?
Quarterly is enough for most small businesses. Compare each result with the same period a year ago.
Where can I find industry averages?
Statistics Canada publishes financial ratios by industry for incorporated enterprises. They are aggregates, so check the industry matches yours and treat them as a rough range.
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