A set of accounts is a large amount of information, and most of it, read line by line, says very little. Revenue was LKR 24 million. Receivables were LKR 4 million. Is that good? You can't tell, because a number on its own has nothing to be compared with.
A ratio fixes that by putting two numbers in relationship. Receivables of LKR 4 million against sales of LKR 24 million a year means customers take about two months to pay. That's something you can act on. So ratios are a way of turning accounts into questions, and the right handful of them, tracked every month, gives an owner a clear picture of the business on a single page.
What I want to do here is choose that handful, explain what each one shows, and then spend some time on how ratios get misread, because that's where most of the value is.
Profitability: is the business earning enough?
Gross margin, gross profit as a share of sales. It shows whether each sale is worth making, and it moves with pricing, supplier costs and discounts. For the retailer we use in our examples: LKR 800,000 ÷ LKR 2,000,000 = 40%.
Net margin, net profit as a share of sales. It shows whether the business as a whole is worth running, after overheads. The retailer: LKR 150,000 ÷ LKR 2,000,000 = 7.5%.
Overheads as a share of sales. LKR 650,000 ÷ LKR 2,000,000 = 32.5%. If this rises month after month, overheads are growing faster than the business.
Efficiency: how fast does money move through the business?
Debtor days, how long customers take to pay on average. Receivables ÷ annual sales × 365. For a business owed LKR 4 million on sales of LKR 24 million a year: about 61 days.
Stock days, how long stock sits before it's sold. Inventory ÷ annual cost of goods sold × 365. LKR 2.4 million of stock against LKR 14.4 million of annual cost of goods: about 61 days.
Creditor days, how long you take to pay suppliers. Payables ÷ annual purchases × 365. LKR 1.2 million owed against LKR 14.4 million of purchases: about 30 days.
Together these three give the cash conversion cycle: 61 + 61 − 30 = 92 days, the time a rupee spends inside the business between paying a supplier and being paid by a customer. Shortening any of the three releases cash.
Liquidity: can the business pay its bills?
The current ratio, current assets divided by current liabilities. It's a quick check of whether the business has enough short-term resources to meet its short-term obligations.
Cash runway, how many months of overheads the cash in the bank would cover if no money came in. LKR 3 million in the bank against LKR 650,000 of monthly overheads is about four and a half months. It's a blunt measure, and it's a good one for owners to know by heart, because it answers the question "how long could we survive a bad patch?"
Debt: how much risk does the borrowing add?
Debt service cover, the cash available each month divided by loan repayments. Above one, the business can make its repayments from its own cash; the higher it is, the more room there is for a bad month.
Debt to equity, total borrowing divided by the owners' equity. It shows how much of the business is funded by lenders compared to the owners. A high figure means the business is more exposed if profits fall.
Growth: is the business getting bigger, and is that healthy?
Revenue growth, this period against the same period last year. Comparing to the same month last year, instead of last month, takes the season out.
And then a few numbers that aren't strictly financial, and that explain the financial ones: the number of active customers, the conversion rate from enquiry to sale, customer acquisition cost, and the share of customers who come back, which, as our guide to getting more customers explains, tends to rise as the customer base grows. These are the drivers. When revenue moves, they tell you why.
Seen together, the ratios form a chain. A falling gross margin means less profit from each sale. Less profit means less cash generated. Rising debtor days mean more of that cash is stuck with customers. And all of it shows up, eventually, as a shrinking cash runway. Each ratio is one link, and reading them together lets you see which link started the problem.
A one-page monthly snapshot
Put these on one page, with the last twelve months in columns so the trends are visible, and review it once a month. It should take less than an hour to produce once the books are up to date, and it will tell you more about the business than any amount of staring at the bank balance.
Does that make sense? A set of ratios works like a car's dashboard. The speedometer, the fuel gauge and the temperature light each tell you something the others can't, and no single one of them tells you whether the drive is going well. You read them together, and you notice when one moves.
How ratios get misread
A ratio is a compressed description of something real. Reading it well means remembering what it compresses.
A ratio can improve for a bad reason. The current ratio rises when stock piles up unsold, because stock counts as a current asset. Debtor days fall when you stop selling on credit to your best wholesale customer. Net margin rises for a month when you postpone the marketing that would have brought next quarter's customers. In each case the ratio looks better and the business is weaker. So every time a ratio moves, ask what moved it.
A single month says little. Ratios move around for ordinary reasons: a large delivery arriving on the 30th, a customer paying a day late, a bonus month. The trend over six or twelve months is what matters.
Comparisons need care. "Good" ratios differ by trade. A supermarket can run on a thin gross margin because it sells high volume and gets paid in cash; a consultancy has a high gross margin and long debtor days. Comparing your ratios with your own history is always valid. Comparing them with other businesses only makes sense if the businesses are alike.
And ratios that are watched can be gamed. If a manager is judged on gross margin, they may push high-margin products customers don't want. If a team is judged on debtor days, they may refuse credit to good customers. A ratio becomes a less honest measure the more someone's reward depends on it. The protection is to watch a few ratios together, so that improving one at the expense of another shows up.
From numbers to decisions
The point of all this is to make decisions earlier and better. Falling gross margin points to pricing or supplier costs. Rising debtor days point to collection. Rising overheads as a share of sales point to costs growing faster than the business. A shrinking cash runway says to act now, before options narrow. A ratio that has changed is a question, and the monthly snapshot is how you make sure the questions get asked while there's still time to answer them.
How Gridwerk helps
Ratio analysis and interpretation, and building KPI dashboards and monthly management reports, are part of our Financial Intelligence service, including help getting the books up to date so the ratios mean something. If you'd like to see your business on one page, start with the free diagnostic. It's eighteen questions, about seven minutes, and then we call you to go through the rest.
Gridwerk diagnostic