To track your business performance, set up calculations in your statements or accounting software, or ask your accountant or advisor to do this for you. Accounting software companies typically offer a range of standard and customisable equations, charts and graphs — and you can set alerts if you approach a limit you’ve set.

These equations are often called ratios, as they measure the difference in size or amount between two things. A simple example is a coffee cart that aims to spend $80 a day to sell $100 worth of drinks. This ratio is 0.2 or 20%.

You can:

• focus on key figures in your statements, eg operating cash flow
• set up your own equation(s)
• use the equations explained below, eg gross profit margin or contribution margin.

Which equation(s) will be most useful depends on your business, industry type, and any risks you spot in your financial statements.

The case studies on this page show how different businesses use their financial figures to spot problems or opportunities, and track progress towards their goals:

• House painter — cash flow problems as customers take a long time to pay.
• Software start-up — ballooning operating costs eat into money needed for growth.
• Bakery — deciding if it’s better to open a second shop or seek more business customers.
• Clothing designer — deciding if it’s worth reducing her cost of goods sold.

What these are: Gross profit margin is for your business as a whole and shows if it earns enough to cover all expenses — and make money.

Contribution margin breaks this down for a specific income stream, eg a popular product line, or outlet A vs outlet B. It shows if it earns enough to cover its variable costs and contribute to fixed costs, eg rent. For example, a bakery keen to expand could use it to compare how sales to walk-in customers vs supplying local cafes contribute to operating costs — see our case study about Dani the baker below.

Why these are useful: Both show how much you spend to make your products or services.

As contribution margin breaks this down for each product line, service or location, you can use it to see which are worth extra effort, eg a marketing campaign or launch in a new market, and which are a drain on your finances.

A product or service doesn’t have to earn a huge profit to make a difference. If it can cover its own costs, and help pay your operating expenses, it is earning its keep. Think first about how you’ll make up the shortfall before you get rid of a low-profit product or service.

To work it out: Both are typically shown as a percentage.

For gross profit margin, you can set up an equation using line items in your income statement.

For contribution margin, make sure your income statement separates fixed costs and variable costs for the products, services or locations you want to analyse. Then set up an equation in your accounting software or spreadsheet — or get your financial advisor to work it out.

What’s good, what’s not: For both, a positive percentage — or even one close to zero — shows earnings are enough to cover cost of goods sold and contribute to operating costs.

A percentage below zero means costs outweigh earnings — you must act fast to stop losing money.

For gross profit margin, check the average (or benchmark) for your industry. Ask your accountant or advisor about data to compare your business with others like it.

How to improve: Ways to boost your margins include:

• raising prices, if customers are willing to pay more
• cutting costs, eg agree new terms with regular suppliers or look for cheaper alternatives.

What these are: Debt to assets ratio looks at all your business’s debts (also called its liabilities) and all its assets.

Current ratio, also called working capital ratio, shows if your business has the ability to pay off its short-term debts using its short-term assets, eg cash, inventory and accounts receivable. It’s to do with paying off your debts due within a year. These are called current liabilities on your balance sheet and include:

• rent or mortgage payments
• money owed to suppliers
• short-term loans and credit cards
• holiday pay
• income tax.

Why they are useful: Debt to assets ratio shows how robust — or vulnerable — your business is. Banks in particular will look at this ratio when deciding how much to lend you. Banks may also set a ratio band you must stay within for the term of the loan.

Current ratio shows how your bills will be paid if your business doesn’t earn enough money. If you can’t pay what you owe, your lender or investor can sell your short-term assets to make up the shortfall. Some industries have benchmarks for this ratio so you can check how you compare to similar businesses. Talk to your advisor about benchmarking.

To work it out: Debt to assets is your total liabilities divided by your total assets.

For current ratio, you can set up this equation in your accounting software or spreadsheet — or get your financial advisor to work it out.

What’s good, what’s not: For both ratios, a result higher than 1.0 shows your assets are worth more than enough to cover your debts. This makes you a safer bet for lenders and investors. Most importantly, it means your business model is on track.

If it’s below 1.0, this is a red flag — you need to fix it, and fast. For lenders and investors, you’re seen as a riskier prospect.

But it also depends on what types of current assets you have. Cash is good for you and your business. Investors and lenders also like cash, or assets that can easily be sold for cash, eg items from your most popular product line.

How to improve: Here are some solutions to common problems — it’s a good idea to talk to your accountant or advisor about which apply to your business.

For current ratio, delve into the assets column on your balance sheet.

If most of it is accounts receivable — money owed by customers paying on credit — check if most pay promptly, or if many take a long time to pay in full. Many businesses get into financial trouble by not staying on top of their accounts receivable. Offering credit can build goodwill, but make sure payment terms are fair to both you and your customer.

Go back over your stocktake figures. Inventory is a current asset, but if it takes too long to sell — or you buy too much at a time — it makes it harder to pay your debts. Paying for inventory before you sell it costs you money, so consider longer payment terms with suppliers — or items you can sell faster.

Also check the liabilities column. If you’re carrying a lot of credit card debt, it’s worth switching this to a loan with a lower interest rate.

Explore how to improve sales. This might mean more marketing or changing your prices.

For debt to assets ratio, look into leasing vs buying key pieces of equipment. Weigh up costs and other pros and cons. Leased equipment is classed as an operating expense, not a liability, and it’s tax deductible. If you buy it, you own an asset used to make money for your business.

What it is: An equation that shows if your business can pay its short-term debts — called current liabilities on your balance sheet — from assets that can easily be turned into cash within 90 days, including:

• dollars and cents in your till or bank account(s)
• accounts receivable
• pre-arranged overdraft.

For this ratio, inventory is subtracted as it can take longer than 90 days to turn into cash. Pre-paid expenses can’t easily be turned into cash, so leave these out too.

Why it’s useful: It’s reassuring to know you can easily free up money to pay debts or buy inventory. And if you can’t, you’ll know in advance to make other arrangements, eg take out a loan or agree a payment plan.

To work it out: Do a stocktake, if applicable, as the equation below will use:

• value of your inventory (zero if you don’t have inventory)
• total of your current assets
• total of your current liabilities.

What’s good, what’s not: A quick ratio higher than 1.0 shows you can afford to pay your bills on time and in full, with cash or assets you can easily turn into cash.

If it’s below 1.0, you’ll struggle to repay what you owe without borrowing money, running up credit card debts, or selling assets.

How to improve: Are you often left with more stock than you can sell? Focus on fixing this. The long-term goal is to speed up sales — review your prices and marketing. In the short-term, you might need to:

• buy or make less at a time
• discount your prices, eg at day’s end for a bakery, an end-of-season sale for a designer.

Review your assets. Sell any you rarely use to free up cash, eg old machinery or equipment.

Avoid paying high interest on credit cards by paying it off on time and in full each month. If you can’t, find a cheaper way to use your bank’s money, eg an overdraft or loan. Investors are unlikely to give you money if it’s solely to cover debts — they want their money to help a business improve and grow. You’re better off borrowing money. Talk to your bank about restructuring your debts, and perhaps paying interest only on a loan.

If your business earns enough to have a lot of extra cash waiting for the right time to use it, look into high-interest accounts. Use our modelling tool to see if it’s a better option than using that spare cash for something else.

Depending on your industry or business size, there are other equations used to analyse performance. These include:

• Inventory turnover — the number of times stock is sold and replaced in a year.
• Return on assets — measures a business’s ability to make money from its assets, and typically only useful for banks.
• Return on equity — measures a business’s ability to turn an investor’s money into profit.

If any of these apply to your business, it’s best to talk to your accountant or advisor about how your results compare to others in your industry.

If you have one, also talk to your board of directors or investor(s) about ways to improve. They will be keen to share their knowledge and insights.