Financial Ratios Every Business Owner Should Know

Introduction
Understanding financial ratios every business owner should know is essential for making smart financial decisions, improving profitability, managing cash flow, evaluating performance, and preparing for financing. Banks, investors, CRA auditors, lenders, and even business partners rely on ratios to assess a company’s financial health. Whether you run a corporation, own a retail business, manage a construction company, operate a Shopify store, or work as a consultant, knowing how to interpret financial ratios helps you stay in control of your business. This guide explains the most important financial ratios, what they mean, how to calculate them, and how to use them to strengthen your business.

Legal and Regulatory Framework
Financial ratios are not regulated directly, but their accuracy depends on proper financial statements prepared under ASPE or IFRS. CRA and Revenu Québec examine financial ratios during audits to detect irregularities such as low margins, liquidity issues, inventory discrepancies, unexplained fluctuations, or mismatched GST/QST trends. Banks require ratio analysis for loans under OSFI and provincial credit policies. Proper bookkeeping and accrual accounting are mandatory for reliable ratio calculations.

Liquidity Ratios
Liquidity ratios measure the business’s ability to meet short-term obligations. They are essential for evaluating financial stability.

1. Current Ratio
Current Ratio = Current Assets ÷ Current Liabilities
A ratio above 1 indicates the business can cover short-term debts. A ratio below 1 signals liquidity risk. This ratio is important for lenders and CRA when reviewing solvency.

2. Quick Ratio (Acid-Test Ratio)
Quick Ratio = (Cash + Accounts Receivable) ÷ Current Liabilities
This ratio excludes inventory. It measures the ability to pay debts immediately. E-commerce businesses with large inventory may have lower quick ratios, which banks analyze closely.

Profitability Ratios
Profitability ratios measure how effectively the business generates profit.

3. Gross Profit Margin
Gross Profit Margin = (Revenue – COGS) ÷ Revenue
A strong gross margin means pricing and cost control are effective. CRA uses gross margin to detect unreported sales or misclassified inventory.

4. Net Profit Margin
Net Profit Margin = Net Income ÷ Revenue
This determines the percentage of profit after all expenses. A low margin may indicate cost inefficiency or pricing issues.

5. Return on Assets (ROA)
ROA = Net Income ÷ Total Assets
This ratio measures how efficiently the business uses assets to generate profit. Important for asset-heavy businesses like real estate, manufacturing, or construction.

6. Return on Equity (ROE)
ROE = Net Income ÷ Shareholder Equity
This measures profitability relative to owner investment. Investors often use ROE to evaluate long-term performance.

Efficiency Ratios
Efficiency ratios measure how well the business uses its resources.

7. Inventory Turnover Ratio
Inventory Turnover = COGS ÷ Average Inventory
High turnover indicates efficient inventory management. Low turnover suggests slow-moving stock or poor purchasing decisions. Shopify and retail businesses rely heavily on this ratio.

8. Accounts Receivable Turnover
AR Turnover = Revenue ÷ Accounts Receivable
This measures how quickly the business collects payment. A low turnover means customers are paying late, hurting cash flow.

9. Accounts Payable Turnover
AP Turnover = Purchases ÷ Accounts Payable
This ratio measures how fast a business pays suppliers. Very high turnover can indicate poor cash-flow management.

Debt and Leverage Ratios
Debt ratios show how much financial risk the business carries.

10. Debt-to-Equity Ratio
Debt-to-Equity = Total Debt ÷ Shareholder Equity
A high ratio indicates heavy reliance on debt. Banks monitor this ratio before approving loans.

11. Interest Coverage Ratio
Interest Coverage = EBIT ÷ Interest Expense
This shows whether the business earns enough to pay loan interest. A low ratio is a major warning sign.

Cash Flow Ratios
Cash flow ratios measure the ability of a business to generate cash.

12. Operating Cash Flow Ratio
Operating Cash Flow ÷ Current Liabilities
A strong ratio means the business generates enough cash from operations to cover obligations. This ratio is essential for lenders and for internal cash-flow planning.

13. Free Cash Flow
Free Cash Flow = Operating Cash Flow – Capital Expenditures
This measures how much real cash the business has after investing in assets. Low free cash flow may indicate cash strain.

Valuation Ratios (Useful for Investors)
Valuation ratios help determine if a business or stock is priced fairly.

14. Price-to-Earnings (P/E) Ratio
P/E = Share Price ÷ Earnings Per Share
Used mainly for publicly traded companies. It shows how the market values future growth.

15. Price-to-Sales (P/S) Ratio
P/S = Market Cap ÷ Revenue
Helpful for evaluating early-stage or high-growth companies with low profit.

How to Analyze Financial Ratios
Ratios must be interpreted in context:
compare ratios to industry benchmarks
review ratios over time (trend analysis)
consider economic conditions
connect ratios to operational results
Financial ratios become powerful only when used regularly for monitoring performance.

How CRA and Revenu Québec Use Ratios in Audits
CRA and ARQ analyze financial ratios to identify:
gross margin inconsistencies
unusual debt levels
cash flow problems affecting tax remittances
inventory discrepancies
profit trends that contradict reported sales
They also compare ratios to industry averages using benchmarking tools. Businesses with abnormal ratios may be selected for audit.

Common Bookkeeping Issues Affecting Ratios
poor inventory tracking
missing invoices
incorrect COGS calculation
not reconciling bank accounts
incorrect GST/QST coding
These errors distort ratios and lead to poor decision-making.

Why Financial Ratios Matter for Financing
Banks use ratios to determine:
creditworthiness
loan repayment ability
interest rates
collateral requirements
Businesses with strong ratios typically secure better financing and negotiate better terms.

Using Ratios for Management Decisions
Business owners should use ratio analysis to:
improve pricing
control costs
manage debt
enhance operational efficiency
increase cash flow
Ratios reveal financial weaknesses early so owners can take corrective action.

Mackisen Strategy
Mackisen CPA analyzes your financial ratios and identifies operational areas to improve profitability and cash flow. We prepare monthly financial statements, calculate key ratios, set performance benchmarks, rebuild incorrect accounting, support financing applications, and ensure your ratios meet CRA, ARQ, and lender expectations.

Real Client Experience
A Montreal retail business had poor gross margins; Mackisen identified COGS issues and corrected pricing strategy. A construction company’s debt-to-equity ratio risked loan denial; we restructured financing and improved ratios. A Shopify store struggled with cash flow; we analyzed turnover ratios and fixed inventory management. A consulting firm improved profitability after using ratio trends identified by Mackisen.

Common Questions
Which ratios matter most? Liquidity, gross margin, and cash flow ratios.
How often should ratios be reviewed? Monthly for active businesses.
Do ratios apply to small businesses? Yes — critical for monitoring financial health.
Can ratios help avoid CRA audits? Yes — consistent ratios reduce red flags.
Do lenders require ratio analysis? Always.

Why Mackisen
With more than 35 years of combined CPA experience, Mackisen CPA Montreal helps business owners understand financial ratios every business owner should know and use them to strengthen profitability, reduce risk, improve cash flow, and ensure audit-proof financial reporting. Our expert team translates numbers into strategy, giving owners complete control over their financial future.