4 Essential Financial Ratios You Need for Cash Flow & Risk Management

Running a small business means juggling a million things at once—from paying bills to keeping the lights on. One day you’re on top of everything, and the next, an unexpected expense throws your cash flow out of balance. Sound familiar? 

For many business owners, managing cash flow and keeping risks in check can feel overwhelming. The financial numbers might be there, but how do you make sense of them? That’s where financial ratios come in. These simple tools help you break down your financial data, so you can spot potential problems and make sure your business is on the right track. 

Let’s explore four essential financial ratios that every business owner needs to know to keep cash flow steady and minimize risks.  

Cash inflow to cash outflow ratio 

Cash inflow to cash outflow ratio is your business’s financial pulse. This financial ratio shows how well your company can cover its short-term debts with available cash, giving you a snapshot of liquidity. 

A high ratio means your business brings in more cash than it needs to cover its expenses, while a lower ratio could signal trouble with paying bills on time. 

Example 

Patty owns Patty’s Pastry Pagoda, a successful bakery. But with high fixed costs, like utilities and ingredient expenses, Patty wants to ensure she can stay on top of her financial obligations. If her business generates $200,000 in cash flow but has $190,000 in current liabilities, her ratio comes out to 1.05. This number indicates that while she’s managing to cover her debts, a bit more cushion would be helpful.  

Here’s how she calculates it

Cash flow ÷ Current liabilities = Cash inflow to cash outflow ratio $200,000 ÷ $190,000 = 1.05 

Current ratio 

The current ratio is a great follow-up to the cash inflow/outflow ratio, offering a more comprehensive view. This ratio considers all of your current assets—both liquid (like cash) and illiquid (like inventory)—to measure how well you can cover your short-term obligations. 

A ratio above 1 is typically healthy, indicating your business can comfortably meet its debts. But a number below 1 suggests you might not have enough assets on hand to handle unexpected expenses. 

Example 

Patty also has $275,000 in assets and $190,000 in liabilities. This gives her a current ratio of 1.4, which means she’s in a stable position to manage short-term costs, barring any surprises. 

Here’s the formula

Current assets ÷ Current liabilities = Current ratio $275,000 ÷ $190,000 = 1.4 

Debt-to-equity ratio 

The debt-to-equity (D/E) ratio helps you understand how much of your business is financed by debt compared to your assets. This is an important ratio when considering loans or investment opportunities, as it shows how much risk your business is carrying. 

A lower D/E ratio suggests you’re relying less on debt, which can be attractive to lenders and investors. However, this ratio can vary depending on your industry. 

Example 

Patty is thinking of taking out a loan for a new pastry oven. But before she makes the leap, she checks her D/E ratio. With $250,000 in assets and $190,000 in liabilities, her D/E ratio is 0.76, meaning she’s in a relatively low-risk position with only $0.76 of debt for every dollar of equity. 

Here’s how she calculated it

Total liabilities ÷ Total equity = Debt-to-equity ratio $190,000 ÷ $250,000 = 0.76 

Operating profit margin 

The operating profit margin measures your profitability before taxes and interest, giving you a clear idea of how efficient your business is at generating profit from operations. It shows how much of your revenue is left after covering operating expenses like wages, rent, and materials.  

A higher operating profit margin means your business is doing a great job at turning revenue into profit. If your margin is low, you might want to re-evaluate pricing strategies or cut down on costs. 

Example 

Patty’s operating profit is $200,000, and her total revenue is $150,000. Her operating profit margin is 1.33, meaning for every dollar Patty earns, 13 cents is profit after paying for daily business operations. 

Here’s the formula

Operating profit ÷ Total revenue = Operating profit margin $200,000 ÷ $150,000 = 1.33 

Make financial ratios work for you 

Financial ratios can give you an instant view of your business’s health. By regularly calculating and reviewing these essential ratios, you can stay on top of cash flow, make informed decisions, and reduce risks. Whether you’re planning for growth or just keeping the doors open, understanding these numbers can give you the confidence to navigate whatever challenges come your way. 

Forwardly is here to make your financial management a whole lot easier. With features that help boost your cash flow and provide clear insights, you’ll feel more confident getting through the ups and downs of running your business. So why not give it a shot? You’ve got this, and Forwardly is right there to support you every step of the way!