When you are asked the question, “how is your company doing?” it is a very different question from “how is business?” The answer to the latter is more of a subjective assessment from you as the business owner. You weigh in your expectations and perceptions of the market, the industry and your personal goals as well as expectations. The question “how is your company doing?” should be understood as “how is your company doing compared to other companies?” and the answer should be given in ratios. In other words, meaningful terms that can be compared between different companies. Comparing the ratios of your company with those of other companies in your industry provides valuable information about your business operations compared to the rest of your industry.
There are five common categorizes of ratios used to analyze businesses:
- Cost Control
The ratios provide vital information of the financial status and direction of your company. They help you make decisions for the future and they allow outsiders, who don’t understand your industry, to understand how your company is doing as well as analyze it in an objective manner.
How to use ratios
Ratios can be used for a snap shot view of your company but are better as tools of measurement over time. For example looking at accounts receivable, which is how we bring cash from the day to day business back into the company, most often one looks at the dollar volume of the receivables and what is outstanding for a given period (30, 60 or 90 day etc.). While that routine is key to the day to day business, looking at the Accounts Receivable Turnover Ratio, see below, in regular intervals tells us how good we are at collecting our receivables.
Likewise we can look at the operating cost going up or down and based on that, have an opinion of how the company is doing. On the other hand, the Operating Expense Ratio, see below, will tell us how efficiently we run our business. Needless to say looking at this ratio at different times will tell us if the efficiency of the company is changing or not.
Which ratios to use
We all look at our businesses differently but have outsiders such as investors, bankers, suppliers and authorities that look at it in a typical way. Therefore, select a few ratios that you think make sense for you. Use them for a few quarters and see if they are meaningful for you. By meaningful, I mean can you correlate changes in the business? The typical owner operator, in any industry, has a feel for how his company is doing. The ratios should be a confirmation of that feel and if they are giving different indications, red flags for emerging changes. Find out from the outside parties that have interest in your business what they want to see and establish the relevant ratios for them as well.
In addition to the typical financial ratios below, I’d like to recommend all portable storage companies to use the following ratios as tools to measure their efficiency and growth.
Fleet Utilization Percentage = Total Number of units on hire/Total Number of units in the rental fleet
Average Rental Rate = Periodic Rental Revenue (28 day or monthly)/Average number of units on hire)
Average Rental Term = Total number of days on hire for the current rental fleet/Number of units on hire
These ratios are specific to our industry, but they tell you a lot about how your business is doing and can compare you to other companies in the industry. Furthermore, they can be easily understood by interested parties outside of the portable storage industry.
The portable storage industry has matured so that companies can be compared to each other and outsiders need to understand how the portable storage companies are doing compared to companies in other industries. While an owner can still measure the status of his company by looking at his yard and conclude that an empty yard equals high utilization and lots of cash in the bank means that business is good, more sophisticated measurements are required. Below is a list of different financial ratios that give vital information regarding a business. Identify the ratios that are consistent with your company’s strategy and those that are consistent with the overall economic cycle and apply them to your business for a period of time. I’d say that a year, on a quarterly basis, is required to obtain meaningful information. Make a habit to include these ratios with your financial reports and compare the numbers between different time periods.
Most often the owner operator is so caught up in the day to day that he misses the vital information provided by the history of his own company. The history is your scorecard and foundation for moving forward, combined with your experience, documented or undocumented, it is a vital tool for moving your company into the future.
Revenue Growth Percentage is the percentage change, up or down, in the revenue that your company generates during a period. Since companies in the portable storage industry often generate revenues from sales of containers, one should use the net sales revenue in calculating this number.
Earnings Growth Percentage is the percentage change, up or down, in the profitability of your company during a given time period.
Changes in the Revenue Growth Percentage tell us if business is up or down in revenue terms. Changes in the Earnings Growth Percentage tell us if the profit is up or down. By comparing the Revenue Growth Percentage to the Earnings Growth Percentage, we can see how the change in profit relates to a change in the revenue. In other words, if the revenue grows by 10% and the earnings grow 10% it is a direct correlation. What we like to see is a positive correlation, in other words, the Earnings Growth Percentage should increase more than the Revenue Growth Percentage because not all expenses should increase as a result of the revenue increasing.
Cost Control Ratios
Gross Margin Percentage is the percentage measurement of the difference between the cost of what we sell or produce versus the sales price we obtain for our products. In the portable storage industry we often talk about making $100 per container sold. While the $100 may be a good deal on a trade, the Gross Merging Percentage can vary widely depending on if the container cost is high or low. For example, the Gross Margin Ratio, when selling a container at $2,500 and making $100 based on a cost of $2,400, is 4% while the same ratio when selling a container at a price of $1,300 based on a cost of $1,200 is 7.7%. The formula you’d use for this number is:
Gross Margin Percentage = (Sales Revenue – Cost of containers) / Sales Revenue
Operating Expense Percentage is a ratio used to compare your operating expenses relative to sales in any given period. The ratio is a helpful tool in measuring how well you control your variable expenses. Do they correlate with the swings in the sales revenue or do you have efficiencies / inefficiencies in your operations that relate to the sales volume?
Operating Expense Percentage = Operating Cost / Sales Revenue
Net Operating Profit Percentage is a ratio that tells you how much of your revenue translates into profits. In other words, if sales are $10,000, how much of that becomes profit that can be reinvested in the company after all expenses are paid for?
Net Operating Profit Percentage = Net Operating Profit / Sales Revenue
Inventory Turnover is a measurement of how many times in a given period you sell your inventory. The ratio is a good indicator of how much money you have tied up in the inventory you use for buying and selling containers. The higher the ratio the more efficiently you use your working capital.
Inventory Turnover Ratio = Cost of goods sold / Average Inventory
Accounts Receivable Turnover is a measurement of how long it takes you to collect your accounts receivable. This index is helpful in understanding how fast you can make your payables. If the ratio says that you collect your receivables on an average in 60 days, you will not be able to commit to making your payables in 30 days unless you have access to another source of cash such as a credit line.
Accounts Receivable Turnover = (Average Accounts Receivable/Sales Revenue)*365
Return on Investment Ratio is a measurement of the return on the money you use in your business.
ROI = Net Profit/ Average Total Liabilities and Equity
Return on Equity Ratio is a measurement of the return on the equity you have in your business.
ROE = Net Profit/Average Equity
Current Ratio Factor indicates your company’s abilities to meet its short term financial obligations. The higher the ratio the better. If the ratio is one, it means that you collect receivables as fast as you have to pay payable. If it is less than one it means that you have to have cash from another source to make your payables and if it is more than one, it means that you have the ability to make your payables and have cash left over.
Current Ratio Factor = Current Assets / Current Liabilities
Debt to Equity Ratio measures how much of your own money you have in the business. It tells you how much you have at risk versus what lenders have at risk and it tells you how you can handle challenging times.
Debt to Equity Raito = Total Debt / Total Liabilities