10 Financial Ratios Every Small Business Should Track
A profit and loss statement tells you what happened. Ratios tell you what it means. Most small business owners track revenue and profit. The ones who survive track these ten numbers.
Why ratios matter more than raw numbers
Your P&L says you made £45,000 net profit last year. Good news? Depends. If revenue was £900,000, that's a 5% margin - one bad quarter from a loss. If revenue was £200,000, that's 22.5% - a healthy, resilient business.
Financial ratios strip away the noise of absolute numbers and expose the relationships underneath. They let you compare this month against last month, this year against last year, your business against your industry. A sole trader turning over £80,000 and a practice billing £2 million can both have a current ratio of 1.2 - and both should be slightly worried about it.
There are dozens of ratios in the textbooks. Most of them are irrelevant to a small business. The ten below are the ones that actually surface problems early enough to do something about them, and signal opportunities you might otherwise miss.
For each ratio, we'll cover what it measures, how to calculate it, what "good" looks like, and where the red flags are. Every example uses real numbers so you can follow the arithmetic yourself.
Liquidity ratios: can you pay your bills?
Profitable businesses go bust. It happens all the time. The cause is almost always the same: they ran out of cash before their profits turned into money they could spend. Liquidity ratios measure exactly this - your ability to meet short-term obligations with the assets you have available right now.
Current Ratio
What it measures: Can you pay your bills over the next 12 months? This is the broadest test of short-term financial health. It compares everything you own that can be converted to cash within a year (current assets) against everything you owe that falls due within a year (current liabilities).
Current Ratio = Current Assets / Current Liabilities
Worked example
A consultancy has £150,000 in current assets (cash, outstanding invoices, prepayments) and £100,000 in current liabilities (trade creditors, tax due, short-term loans). Current ratio: £150,000 / £100,000 = 1.5. For every £1 they owe in the next year, they have £1.50 available to pay it.
What good looks like
Target range: 1.5 – 3.0.
Below 1.0 means your current liabilities exceed your current assets - a potential cash crisis. You may not be able to pay suppliers, tax bills, or staff without borrowing or selling long-term assets.
Above 3.0 isn't necessarily a problem, but it usually means money is sitting idle when it could be invested back into the business, paying down debt, or earning a return elsewhere.
Quick Ratio (Acid Test)
What it measures: The same question as the current ratio, but harder. It strips out inventory because inventory isn't cash - it's product sitting on shelves that might not sell, might be obsolete, or might take months to shift. If you had to pay every bill tomorrow with no credit and no fire sale, could you do it?
Quick Ratio = (Current Assets - Inventory) / Current Liabilities
Worked example
A retail business has £200,000 in current assets, of which £85,000 is inventory. Current liabilities are £120,000. Quick ratio: (£200,000 - £85,000) / £120,000 = 0.96. Despite a healthy-looking current ratio of 1.67, strip out the stock and they're borderline. If those goods don't sell, they'll struggle to pay their bills.
What good looks like
Target range: 1.0 – 2.0.
This ratio matters most for product businesses - retailers, manufacturers, wholesalers. Service businesses with no inventory will find their quick ratio and current ratio are identical, which is fine. Below 1.0 for a product business is a warning sign: you're relying on selling stock to meet your obligations.
Profitability ratios: what are you actually keeping?
Revenue is vanity, profit is sanity. But even "profit" has layers. Gross profit tells you whether your core product or service is viable. Operating profit tells you whether your overheads are under control. Net profit tells you what's left after absolutely everything. These three margins, taken together, tell you exactly where money is leaking out of the business.
Gross Profit Margin
What it measures: How much you keep from every pound of revenue after paying the direct costs of delivering your product or service. Direct costs (cost of goods sold) means materials, manufacturing, direct labour - anything that scales directly with what you sell.
Gross Profit Margin = (Revenue - COGS) / Revenue × 100
Worked example
A furniture maker generates £300,000 in revenue. Wood, fabric, workshop supplies, and direct labour cost £180,000. Gross profit: £120,000. Gross margin: £120,000 / £300,000 × 100 = 40%. For every £1 of revenue, £0.40 is available to cover rent, marketing, admin, and profit.
What good looks like
This varies enormously by industry, which is why comparing against sector benchmarks matters:
- Professional services: 50–80% (low direct costs)
- Retail: 25–50%
- Manufacturing: 25–45%
- Hospitality: 60–70% (food/drink markup is high; the challenge is overheads)
A declining gross margin with stable revenue is one of the most important early warning signals in business. It usually means either your input costs are rising or you're discounting to maintain volume. Both need attention immediately.
Net Profit Margin
What it measures: What's actually left after every single cost: direct costs, overheads, rent, utilities, marketing, salaries, interest, depreciation, tax. This is the bottom line. The number that determines whether the business is worth running.
Net Profit Margin = Net Profit / Revenue × 100
Worked example
An e-commerce business turns over £500,000. After all costs - products, fulfilment, marketing, platform fees, staff, rent, everything - net profit is £60,000. Net margin: £60,000 / £500,000 × 100 = 12%. Decent. Not spectacular. But sustainable.
What good looks like
Target: 10–20% for most small businesses.
Below 5% is the danger zone. You're one bad month, one lost client, or one unexpected cost away from a loss. There's no buffer. No margin for error. You're running a business on the assumption that nothing will go wrong, and something always goes wrong.
Above 20% is excellent, but make sure you're not under-investing. Some businesses achieve high net margins by not spending on marketing, training, or maintenance - which works until it suddenly doesn't.
Operating Profit Margin
What it measures: Profitability from core operations. It strips out interest payments and tax - things influenced by your financing decisions and your tax structure rather than how well you actually run the business. This is the ratio that tells you whether the operation itself is sound, independent of how it's funded.
Operating Profit Margin = Operating Profit / Revenue × 100
Worked example
A construction firm has £1.2 million in revenue, £780,000 in direct costs, and £300,000 in operating expenses (staff, vehicles, insurance, office). Operating profit: £120,000. Operating margin: £120,000 / £1,200,000 × 100 = 10%. They then pay £30,000 in loan interest and £18,000 in tax, leaving £72,000 net profit (6% net margin). The operational performance is solid; it's the debt that's compressing the bottom line.
Why this matters more than you think
If your operating margin is healthy but net margin is thin, the problem isn't the business - it's the capital structure. Maybe you have too much debt. Maybe you're paying too much interest. Maybe refinancing or restructuring would transform your results without changing a single operational process. You can't see this from the net margin alone.
Efficiency ratios: how fast does cash move?
You can be profitable on paper and still run out of cash. Efficiency ratios measure the speed at which money flows through your business - how quickly clients pay you, how long you take to pay suppliers, and how fast inventory converts into revenue. In a small business, these ratios are often the difference between comfort and crisis.
Debtor Days (Receivables Days)
What it measures: How long it takes your clients to pay you after you've invoiced them. Every day between issuing an invoice and receiving the money is a day you're effectively lending your clients an interest-free loan.
Debtor Days = Trade Receivables / Revenue × 365
Worked example
An accountancy practice has £45,000 in outstanding invoices at the balance sheet date and annual revenue of £360,000. Debtor days: £45,000 / £360,000 × 365 = 46 days. If their standard terms are 30 days, clients are, on average, paying two weeks late.
What good looks like
Target: 30–45 days. Above 60 is a cash flow problem regardless of how profitable you are.
The UK average sits around 51 days, and late payment costs UK small businesses billions annually. If your debtor days are creeping up quarter-on-quarter, you don't have a revenue problem - you have a collection problem. Tighter credit terms, earlier invoicing, automated payment reminders, or simply picking up the phone can shift this number dramatically.
Creditor Days (Payables Days)
What it measures: How long you take to pay your suppliers. This is the mirror image of debtor days. A longer creditor days figure means you're holding onto cash for longer before it leaves the business - which can be a deliberate working capital strategy or a sign that you're stretching suppliers because cash is tight.
Creditor Days = Trade Payables / Cost of Sales × 365
Worked example
A retailer has £65,000 in trade payables and annual cost of sales of £400,000. Creditor days: £65,000 / £400,000 × 365 = 59 days.
The strategic insight
The relationship between debtor days and creditor days is where the real insight lives. If your debtor days are 45 and your creditor days are 60, your suppliers are effectively funding your working capital - you're collecting from customers before you have to pay your suppliers. If it's the other way around (debtors 60, creditors 30), you're funding your customers' cash flow out of your own pocket. That's a working capital gap, and it's one of the most common reasons small businesses need overdraft facilities they'd rather not have.
Stock Turnover (Inventory Turnover)
What it measures: How many times you sell through your entire inventory in a year. Higher is generally better - it means stock isn't sitting around gathering dust and tying up cash. This ratio is only relevant if you carry physical inventory. Service businesses can skip it.
Stock Turnover = Cost of Sales / Average Inventory
Worked example
A wholesaler has £600,000 in cost of sales and average inventory of £100,000. Stock turnover: £600,000 / £100,000 = 6 times per year. That means they sell through their entire stock roughly every two months. Compare this to a specialist art dealer who might turn stock once or twice a year - completely different business model, completely different expectation.
Red flag: declining stock turnover
If this number is falling over time, stock is accumulating. That means cash is locked up in product that isn't moving. Questions to ask: Are you over-ordering? Has demand dropped? Are certain product lines dead stock? Every pound tied up in unsold inventory is a pound you can't spend on something productive. Seasonal businesses should compare like-for-like periods (Q4 this year vs Q4 last year), not sequential quarters.
Return ratios: is your money working hard enough?
You've put money into this business. Maybe a lot of it. Return ratios answer the most fundamental question in business ownership: is your capital earning a better return here than it would anywhere else?
Return on Equity (ROE)
What it measures: The return generated on the money invested in the business by its owners. This is your personal return on the capital you've committed. It answers the question: "Is this business a better investment than the alternatives?"
Return on Equity = Net Profit / Shareholders' Equity × 100
Worked example
A small business owner has £120,000 of equity in the business (initial investment plus retained earnings). The business made £24,000 net profit this year. ROE: £24,000 / £120,000 × 100 = 20%. That £120,000 earned a 20% return. For context, a UK savings account pays around 4–5%, and the long-term average stock market return is roughly 8–10%. At 20%, the business is handsomely outperforming both.
What good looks like
Target: 15–25%.
Below 10% and you should seriously ask whether the time, stress, and risk of running a business is justified compared to putting the same capital in an index fund. Above 25% is excellent but investigate whether it's sustainable or driven by a one-off event. Also watch for businesses with very low equity (perhaps because profits have been drawn out aggressively) - the ROE will look high, but the business may be fragile.
Return on Assets (ROA)
What it measures: How efficiently the business uses everything it owns - cash, equipment, property, vehicles, inventory, receivables - to generate profit. ROA doesn't care how the assets are funded (debt or equity). It's a pure measure of operational efficiency.
Return on Assets = Net Profit / Total Assets × 100
Worked example
A design agency has total assets of £80,000 (mostly cash and receivables - they're asset-light) and net profit of £32,000. ROA: £32,000 / £80,000 × 100 = 40%. Excellent. Compare this to a manufacturing business with £500,000 in assets (machinery, warehouse, stock) and £40,000 net profit: ROA of 8%. Both might be performing well for their sector, but the numbers are fundamentally different because the business models are.
What good looks like
Depends on the business model.
- Asset-light businesses (consultancy, agencies, freelancers): 20%+ is achievable
- Asset-heavy businesses (manufacturing, construction, property): 5–10% is normal
The key insight from ROA is whether you're making efficient use of your assets. If you've invested in expensive equipment that sits idle half the time, or hold property that doesn't contribute to revenue, ROA will expose it.
How to read ratios together
No ratio means much in isolation. The diagnostic power comes from reading them as a set - the way a doctor reads blood pressure alongside cholesterol, not instead of it. Here are three patterns that show up constantly in small business accounts:
High gross margin + low net margin = overheads are the problem
Your product or service is priced correctly. The direct economics work. But somewhere between gross profit and net profit, money is disappearing. The culprit is usually rent, staff costs, or marketing spend that's grown faster than revenue. This pattern tells you to look at your P&L line by line, starting from the biggest overhead downward.
Good current ratio + high debtor days = profitable but cash-poor
On paper, you have more assets than liabilities. But those "assets" are sitting in unpaid invoices while your bills are due now. This is the classic profitable-but-struggling trap. The business is generating value; it just can't access it fast enough. The fix is usually about collection processes, not about working harder or selling more.
Declining gross margin + stable revenue = pricing pressure or cost inflation
Revenue hasn't changed, but you're keeping less of each pound. Either your input costs have risen (materials, supplier prices, wages) and you haven't passed them on, or you're discounting to hold market share. If this trend continues for two or three quarters, your net margin is next. This ratio combination is the earliest possible warning of a price-cost squeeze.
The diagnosis method
Start with the profitability ratios to understand the broad health. Then use the efficiency ratios to understand cash timing. Then check liquidity to see if the cash position matches the profit position. If there's a gap - profitable business, tight liquidity - the efficiency ratios will tell you why.
Industry benchmarks
The table below provides median benchmarks for six common small business sectors. These are guide figures, not targets. A furniture maker in rural Wales and a furniture maker in central London face entirely different cost structures, and their "healthy" ratios will differ accordingly. Use these as a starting point for comparison, not as a pass/fail test.
| Ratio | Prof. Services | Retail | E-commerce | Construction | Hospitality | Manufacturing |
|---|---|---|---|---|---|---|
| Current Ratio | 1.5–2.5 | 1.2–2.0 | 1.3–2.0 | 1.1–1.8 | 0.8–1.5 | 1.3–2.0 |
| Quick Ratio | 1.5–2.5 | 0.5–1.0 | 0.8–1.5 | 0.9–1.5 | 0.6–1.2 | 0.7–1.2 |
| Gross Margin | 50–80% | 30–50% | 35–55% | 15–30% | 60–70% | 25–45% |
| Net Margin | 15–25% | 3–8% | 5–15% | 3–8% | 3–10% | 5–12% |
| Operating Margin | 20–30% | 5–12% | 8–18% | 5–12% | 5–15% | 8–15% |
| Debtor Days | 30–60 | 5–15 | 0–5 | 45–75 | 0–5 | 40–65 |
| Creditor Days | 15–30 | 30–50 | 20–40 | 40–60 | 15–30 | 35–55 |
| Stock Turnover | n/a | 4–8× | 6–12× | 6–10× | 20–40× | 4–8× |
| ROE | 20–35% | 10–20% | 15–25% | 10–20% | 8–18% | 10–20% |
| ROA | 15–30% | 5–12% | 8–18% | 4–10% | 3–10% | 4–10% |
Notice how hospitality has a current ratio below 1.0 at the low end. That's not unusual for pubs and restaurants - they collect cash immediately from customers but have monthly bills to suppliers. It doesn't necessarily mean insolvency; it means the business model runs on tight cash cycles. Context always matters more than absolute numbers.
How often to calculate these
The answer depends on how quickly you want to spot problems.
Minimum: Quarterly
- Catches seasonal shifts
- Aligns with VAT returns
- Four data points per year
- Better than most small businesses currently manage
Better: Monthly
- Catches trends within quarters
- Twelve data points per year
- Takes ~30 minutes with the right data
- Turns annual surprises into monthly course corrections
The constraint is rarely the calculation itself. It's getting the data. If your books are three months behind, your ratios are three months behind. Monthly ratio tracking requires monthly bookkeeping - which means bank reconciliation, expense categorisation, and income posting have to happen in the weeks after each month closes, not the weeks before the tax return is due.
The ideal is a real-time dashboard where these numbers update automatically as your accounting data changes. Upload a general ledger export, and every ratio recalculates instantly. No spreadsheet formulas. No manual data entry. No stale numbers.
The practical shortcut
LedgerIQ calculates all ten of these ratios - plus over thirty more - automatically from a single GL export. Upload your general ledger data from any accounting platform, and within seconds you have a complete ratio dashboard with trend analysis, anomaly detection, and industry comparison. It turns a 30-minute spreadsheet exercise into a 30-second upload.
Common mistakes when using financial ratios
Ratios are powerful tools, but they're easily misused. These are the mistakes we see most often:
Comparing against the wrong benchmarks
A construction firm comparing its gross margin against a software company will conclude it's failing. It isn't. It's just in a different business. Always compare within your sector, and ideally within your size bracket. A £100,000 turnover sole trader and a £10 million turnover limited company face different cost dynamics even within the same industry.
Looking at a single snapshot instead of trends
A current ratio of 1.8 tells you almost nothing on its own. A current ratio that's dropped from 2.5 to 1.8 to 1.3 over three quarters tells you something urgent. Ratios are most useful as time series. Plot them. Watch the direction. A "good" number that's deteriorating is more concerning than a "mediocre" number that's improving.
Ignoring seasonality
A gift shop's December current ratio will look completely different from its February current ratio. Comparing sequential quarters without adjusting for seasonality will generate false alarms and false comfort in equal measure. Compare Q1 this year against Q1 last year, not against Q4 last year.
Using annual figures when monthly would catch problems earlier
Annual figures smooth out volatility, which is both their strength and their weakness. A business that was profitable for nine months and bleeding cash for three will show a tidy annual profit. Monthly ratios would have caught the bleed in month ten. By the time the annual accounts arrive, the horse has been gone for months.
Not adjusting for one-off items
You sold a vehicle for £15,000 and booked a profit on disposal. Your net margin spiked. You didn't suddenly become a better business - you sold an asset. One-off items (asset sales, insurance payouts, legal settlements, redundancy costs) distort ratios and need to be stripped out for meaningful comparison. Calculate the "underlying" number alongside the reported one.
The fundamental rule
Ratios raise questions. They don't answer them. A current ratio of 0.8 doesn't tell you what to do - it tells you to find out why and decide what to do. The number is the starting point of the investigation, not the conclusion.
All ten ratios. Calculated in seconds.
LedgerIQ turns a general ledger export into a complete financial analysis dashboard - all ten ratios above, plus trend analysis, anomaly detection, and thirty more modules. Upload once. Analyse everything.
Try LedgerIQ FreeFrequently Asked Questions
What are the most important financial ratios for small businesses?
The essential ratios are current ratio (liquidity), gross profit margin and net profit margin (profitability), debtor days and creditor days (efficiency), and return on equity (performance). These six ratios give a comprehensive overview of financial health.
How often should I calculate financial ratios?
Calculate key ratios monthly as part of your management reporting. Quarterly is the minimum frequency to identify trends before they become problems. Annual ratio calculation is too infrequent to be actionable for most businesses.
What is a good current ratio for a UK small business?
A current ratio between 1.5 and 2.0 is generally healthy for UK small businesses. Below 1.0 means the business cannot cover its short-term obligations. Above 3.0 may indicate excess cash that could be invested more productively.
How do I calculate debtor days?
Debtor days equals trade receivables divided by annual credit sales, multiplied by 365. For example, if you have £50,000 in receivables and £300,000 in annual sales, debtor days is (50,000 / 300,000) x 365 = 61 days.