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One of the most common types of financial statements used by businesses is the income statement. Also known as a profit and loss statement, an income statement shows a company’s income and expenditures and whether that company is making a profit or loss for a given period.

There is more than one type of income statement, but the one most widely used by businesses, and accepted by the Generally Accepted Accounting Principles (GAAP), is the traditional income statement.

Here’s what you need to know about traditional income statements, including an example of a traditional format income statement, plus how these statements differ from contribution margin income statements.

What Are Traditional Income Statements?

Traditional income statements record both the income and expenses of a business and show how profitable a business was during a particular period, such as a month, quarter, or year. Because a traditional income statement captures all the costs associated with manufacturing a product (both fixed and variable), it’s sometimes referred to as the absorption costing income statement.

The income statement is one of the three most important financial statements in financial accounting, along with the balance sheet and the cash flow statement.

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Calculating the Components of Traditional Income Statements

Here’s a look at the common components included in a traditional income statement.

Sales Revenue

The first section of the income statement provides a summary of the company’s gross sales. In some cases, revenue may be divided into two types — operating revenue (the revenue gained by a company’s primary activities) and nonoperating revenue (the revenue gained from non-core business activities).

Cost of Goods Sold

Commonly referred to as COGS, this is how much it cost to produce all the goods or services that were sold during the reporting period. If a company is a service business, this might be referred to as Cost of Sales.

COGS only includes the cost of items actually sold and only direct costs (such as raw materials, labor, and shipping). It doesn’t include indirect costs, such as overhead. This number may fluctuate each period, depending on how many units were sold.

Gross Profit

Gross profit is calculated by subtracting total COGS from total sales revenue. This is the amount left over after the costs for manufacturing the products have been paid. However, gross profit does not include general overhead expenses.

Selling, General, & Administrative Expenses

Also referred to as “general expenses” or “operating expenses,” selling, general and administrative (SG&A) expenses are expenses the business incurs outside of the costs directly involved in developing its products or services. This may include marketing, advertising, rent, utilities, sales, and accounting. These expenses act as a separate line item from COGS on the traditional income statement.

Operating Income

Once you calculate gross profit, you can subtract those SG&A expenses to calculate operating income. This is the amount the business has available in working capital once all expenses are paid. Operating income tells you how much your business made after subtracting all internal costs (which are costs you can control) but before covering external expenses, such as interest on loans and taxes (which you have less control over).

Interest Expense

This includes the total amount of interest a business pays on any debt, such as different types of small business loans.

Earnings Before Income Tax

This is the business’s profitability before it pays its taxes.

Income Tax Expense

This is how much the business paid in income taxes during the accounting period.

Net Profit

Also known as a company’s “bottom line,” net profit is the total profit a business has earned after subtracting total expenses from total revenue.

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Pros and Cons of Using Traditional Income Statements

So should your company use a traditional income statement? Here’s a look at some of the pros and cons of preparing this type of financial statement as part of your business cash management.

Traditional Income Statements vs Contribution Income Statements

Another type of income statement is the contribution (or contribution margin) income statement.

While there are similarities between these two types of financial statements, there are also some key differences.The traditional and contribution margin income statements both provide information about a company’s revenues, expenses, and profits (or losses) for a defined period. For both, the top line is revenue and the bottom line is net income. Where they differ is how they arrive at that bottom line.

A traditional income statement separates costs by production/manufacturing costs (both variable and fixed) and period/overhead costs. The contribution margin income statement, on the other hand, separates costs into variable and fixed. Fixed manufacturing costs are considered part of overhead costs and, as a result, are not included in production costs.

Also, a contribution margin income statement deducts variable expenses from sales to arrive at a “contribution margin.” A contribution margin is essentially how much of a company’s revenues are contributing to its fixed costs and net income. Once the contribution margin is calculated, you then subtract all applicable fixed costs to arrive at a net profit for that period.

Typically, a company will use a traditional income statement for external reporting purposes and a contribution margin income statement to analyze the performance of a specific product or product category internally.

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Traditional Income Statement Example and Format

Here’s an example of a traditional income statement for a fictional company that manufactures widgets. Last quarter, the company generated $200,000 in sales. Its COGS was $110,000, and SG&A expenses were $48,200.

The Takeaway

A traditional income statement shows business revenue minus expenses and losses for a certain accounting period. It tells you how much income your business netted during that period of time.

Preparing income statements on a regular basis can help you analyze trends within your company, determine if your expenses and/or prices are too high or too low, and make plans for the future, such as whether or not to apply for a small business loan.

If you’re seeking financing for your business, SoFi can help. On SoFi’s marketplace, you can shop top providers today to access the capital you need. Find a personalized business financing option today in minutes.

FAQ

How are traditional income statements vs contribution income statements different?

A traditional income statement separates costs by production costs and overhead costs, includes both fixed and variable expenses, and calculates gross profit. The contribution margin income statement, on the other hand, separates costs into variable and fixed costs and calculates a “contribution margin.” Fixed manufacturing costs are considered part of overhead costs and, as a result, are not included in production costs.

What kinds of businesses use traditional income statements?

Any type of business can benefit from preparing a traditional income statement, since it shows whether or not a company has been profitable. In addition, you may need a traditional income statement if you decide to seek outside funding. Lenders and investors often want to see a company’s traditional income statements to learn more about the firm’s revenue, expenses, profitability, and debt.

How do traditional income statements classify costs?

Traditional income statements classify costs by manufacturing costs and non-manufacturing expenses (or operating expenses).

Photo credit: iStock/AmnajKhetsamtip

SoFi's marketplace is owned and operated by SoFi Lending Corp. See SoFi Lending Corp. licensing information below. Advertising Disclosures: SoFi receives compensation in the event you obtain a loan through SoFi’s marketplace. This affects whether a product or service is featured on this site and could affect the order of presentation. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

SOSB0424022

If you’re considering taking out a business loan, you’ll want to make sure your company looks like a safe bet in the eyes of a lender. One of the metrics they may look at is your debt/EBITDA (earnings before interest, taxes, depreciation, and amortization) ratio.

Debt-to-EBITA is a financial metric that looks at how much of the income your business is generating is available to pay down debt before covering interest, taxes, depreciation, and amortization expenses.

Read on to learn how this ratio is calculated, and how to know if your company’s debt/EBITDA is healthy.

What Is Debt-to-EBITDA?

Simply put, debt-to-EBITDA measures the ability of your company to pay its debts off. It compares your actual cash earnings to your financial obligations, including debt and other liabilities.

A high debt-EBITDA ratio might result in a lower credit score for your business, whereas a lower ratio could positively impact your credit profile, making it easier to qualify for financing at favorable rates and terms.

What Is EBITDA?

Before we go deeper into the debt-to-EBITDA ratio, it’s important to understand exactly what EBITDA is.

EBITDA stands for earnings before interest, tax, depreciation, and amortization. It is a measurement of a company’s profitability before those expenses are taken out.

While not accepted by GAAP (generally accepted accounting principles, EBITDA is often used by analysts and investors to compare the profitability of two companies in the same industry.

The reason is that EBITDA removes expenses that can vary depending on a company’s capital structure (and how much it spends on interest on debt), historical investments (which affects its depreciation and amortization expenses), and tax burden (which can vary from state to state).

You can calculate EBITDA by looking at your income statement and adding interest, tax, depreciation, and amortization back to net income.

EBITDA = Net Income + Interest + Taxes + Amortization + Depreciation

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What Is Debt?

Debt is anything your company owes another company or individual and includes both short-term and long-term debt obligations. You can find these numbers in a company’s quarterly and annual financial statements.

Exactly what obligations are included in total debt for the Debt/EBITDA ratio, however, is somewhat open to interpretation. Often, it’s defined as all interest-bearing liabilities, such as small business loans.

If you want to take on more debt, lenders may look at financial metrics like your debt-to-income ratio, debt-to-equity ratio, and your debt-to-EBITDA ratio. All of these can help a lender understand the likelihood of your being able to repay a new loan with the given amount of debt you currently have.

Debt-to-EBITDA Ratio Formula

To calculate the ratio for debt to EBITDA, you would use this formula.

Debt/EBITDA ratio = Liabilities/EBITDA

How the Debt-to-EBITDA Ratio Works

The debt/EBITDA ratio compares a company’s total liabilities to the actual cash it is bringing in. The goal of this financial ratio is to show how capable the business is of paying its debt and other liabilities.

Generally, the lower the debt-to-EBITDA ratio, the more money your company has available to cover its financial obligations when they come due. A higher debt/EBITDA ratio, on the other hand, suggests that the business is heavily leveraged and might run into trouble paying upon its debts.

What’s considered a good debt/EBITDA ratio will vary by industry. Generally speaking, however, a ratio of 4 or 5 is considered to be high. This may be a red flag to potential investors or lenders that your business is over leveraged and could potentially default on its debts.

Calculating Debt-to-EBITDA

Calculating the debt/EBITDA ratio is done by dividing a company’s short-term debts and long-term debts by its EBITDA (earnings before Interest, Taxes, Depreciation, and Amortization). The main goal of this ratio is to reflect the amount of cash available with the company to pay back its debts.

Recommended: What is GAAP?

Uses of Debt-to-EBITDA

So when would you actually use your debt-to EBITDA ratio? If you’re looking to borrow money for your business, before you get to the business loan application process, it can be smart to calculate your debt/EBITDA ratio so you know where you stand.

If you borrow money from a bank, there may be a requirement to meet a certain debt-to-EBITDA ratio in your loan agreement. If you can’t keep that ratio, you may risk the loan being called.

If you are considering bringing on investors, they may also want to look at your debt/EBITDA. Investors will often use this ratio to gauge the approximate amount of time it will take a company to pay off all of its debts with its available cash.

Recommended: How to Read Financial Statements

Pros and Cons of Using the Debt-to-EBITDA Ratio

There are both benefits and drawbacks to using debt-to-EBITDA ratio to assess the financial health of a business. Here’s how they stack up.

Pros

Debt-to-EBITDA. It’s simple to calculate: Debt can be found on the balance sheet and EBITDA can be calculated from the income statement. As a result, this ratio can be a quick way to get a snapshot of a company’s financial health and liquidity.

The debt/EBITDA ratio is also popular with analysts because it relates the debts of a company to its business cash flow by ignoring non-cash expenses. This is important because, in the end, It’s cash, and not profits, that is needed to pay off debts.

Cons

Because EBITDA adds interest, taxes, depreciation, and amortization to net income, it may not provide an accurate measure of a firm’s actual earnings. If any of these variables are high, it could impact a company’s ability to pay debts.

In addition, debt/EBITDA may not be useful for comparing companies in different industries. Capital requirements vary by industry and, as a result, some companies need to carry a higher debt loan than others. For this reason, using debt/EBITDA to compare firms across industries may not be reliable.

Debt-To-EBITDA Ratio Example

Let’s look at an illustration of how the total debt to EBITDA ratio can indicate a company’s financial health (or lack thereof).

Calculation Example

Let’s say company ABC’s EBITDA is $10 million, and its debts add up to $30 million. To calculate ABC’s debt-to-EBITDA ratio, you would calculate:

Debt/EBITDA = $30 million/$10 million

Debt/EBITDA = 3

A debt-EBITDA ratio of 3 is generally considered low and indicates that ABC has revenue to cover its debts. A lender may look at that ratio and decide ABC isn’t a risk and approve a loan.

Here’s another example: Let’s say company XYZ has an EBITDA of $10 million, but has $50 million in debt. This would be it’s ratio:

Debt/EBITDA = $60 million/$10 million

Debt/EBITDA = 6

Depending on the industry, a ratio of 6 may be considered high and could make it difficult for XYZ to get a good credit rating and qualify for any additional financing.

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The Takeaway

The debt/EBITDA ratio reveals how much actual cash a company has available to cover its debt. It is one of many financial metrics used by lenders, analysts, and investors to gauge a company’s liquidity and financial health.

As a business owner, it can be a good idea to periodically calculate your company’s debt/EBITDA ratio. It can give you insights into your company’s current financial position, and also help you see trends over time. If you see the ratio going down, for example, it means that you are paying down debt, the company’s earnings are going up, or both.

If you’re seeking financing for your business, SoFi can help. On SoFi’s marketplace, you can shop top providers today to access the capital you need. Find a personalized business financing option today in minutes.

FAQ

What is considered a good debt-to-EBITDA?

A good debt-to-EBITDA ratio will depend on your industry. Generally, however, a ratio of three or less can indicate that your business has enough cash flow to comfortably cover its debts.

Is debt included in EBITDA?

Yes. EBITDA stands for earnings before interest, tax, depreciation, and amortization. Interest represents the interest your business is paying on its debts.

What does debt-to-EBITDA indicate?

The debt-to-EBITDA ratio indicates how much income you have available to pay down debt before covering interest, taxes, depreciation, and amortization expenses.

Photo credit: iStock/sanjeri

SoFi's marketplace is owned and operated by SoFi Lending Corp. See SoFi Lending Corp. licensing information below. Advertising Disclosures: SoFi receives compensation in the event you obtain a loan through SoFi’s marketplace. This affects whether a product or service is featured on this site and could affect the order of presentation. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

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Assessing cash flow is an essential step in understanding how operating expenses impact your business’s bottom line.

Many companies use accounting software to do the job. But, depending on the complexity of your business, it may be possible to calculate cash flow using a spreadsheet and some basic math formulas.

Read on to learn how to calculate cash flow.

Why Understanding Cash Flow Is Important

Calculating cash flow lets you see how your business’s expenses (outflows) compare to your company’s income (inflows). A business generally needs to be cash flow positive, meaning monthly revenue exceeds your operating expenses, to maintain a sustained, profitable existence.

Understanding your cash flow cycle also helps you make financial projections, which can inform your decision-making process. Just a few of the things this knowledge can help with include:

•   Anticipating inventory needs, including how to pay for supplies

•   Determining if your prices are reasonable

•   Projecting your fixed expenses versus seasonal revenue

Your cash flow projections can help you figure out how you’re going to finance the lean months while being fully prepared for your busy months.

When you’re cash flow positive, you’re likely offering the right services at the right price. But if your revenue isn’t covering your operating expenses, it may be time to rethink your business structure.

No matter what type of business you operate, your cash flow is one of the most critical financial components to understand. Not only does it help you manage your business’s accounts, but it’s also often required by lenders and investors when you apply for financing.

How Is Cash Flow Calculated?

At its core, cash flow involves subtracting monthly expenses from your monthly balance and income. The money you can transfer to the next month’s balance is your cash flow.

More complex businesses can identify separate categories for cash flow from operations, investing, and financing.

Here, we’ll discuss a few different cash flow formulas: operating cash flow, free cash flow, cash flow forecasting, and discounted cash flow.

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Operating Cash Flow Formula

Your operating cash flow looks at whether your company is making a net profit from its core business operations. It hones in on cash inflows and outflows from a company’s core operations and ignores cash flows related to outside investing or non-core operations.

Any revenue your company has brought in through sales is called your “cash in.”

The expenses, such as rent, payments on small business loans, credit card payments, taxes, salaries, and manufacturing, are called “cash out.”

To calculate your operating cash flow, take the following steps each month:

1.    Add the starting balance and revenue to determine your cash in.

2.    Add up all expenses to determine cash out.

3.    Subtract cash out from cash in.

Your remaining amount is your operating cash flow for the month.

(The formula can include other things for more complex businesses, such as depreciation, but let’s keep things comparatively simple for now.)

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Operating Cash Flow Example

Let’s look at an example for an imaginary company:

XYZ Retail had a balance of $100,000 roll over from June into July. In July, XYZ Retail grossed $400,000 in revenue. Its total cash in is $500,000.

XYZ Retail’s expenses for the month totaled $250,000, and taxes on the profit amounted to $62,500. Its total cash out is $312,500.

As the formula for operating cash flow is:

Cash In – Cash Out = Operating Cash Flow

XYZ Retail’s formula would look like this:

$500,000 – $312,500 = $187,500

Therefore, XYZ Retail has $187,500 of cash flow to roll over. The company will add the $187,500 balance to whatever revenue they make the next month.

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Free Cash Flow Formula

Calculating your free cash flow allows you to determine how much spending money you have after determining operating cash flow and capital expenses.

Capital expenses are funds invested in the long-term life of your business and spent on larger scale purchases like trucks, large machinery, and building purchases. This differs from operating costs because those are day-to-day expenses such as salaries, smaller supplies (e.g., copiers and computers), and building rentals, not purchases.

Once free cash flow has reached an amount with which a business owner is comfortable, the owner typically uses the funds to make decisions about the future. Seeking to expand? Finding ways to lower other costs, which could cost money upfront? Hiring additional people or an outside company to provide support?

Investors also use free cash flow reports to decide if a company is worth investing in.

While a high free cash flow is preferred, a low one doesn’t mean a business is failing. Newer companies rarely have much free cash flow as they’re making significant initial purchases.

The older a business is, the more likely it is to have free cash flow, but even these older businesses can have low amounts if they make large purchases.

There are a few ways to calculate free cash flow. However, the simplest takes the following steps:

1.    Determine operating cash flow (see the formula in the previous section).

2.    Add up capital expenditures.

3.    Subtract capital expenditures from operating cash flow.

There are other formulas for calculating free cash flow. But they’re usually for instances where a company hasn’t been closely monitoring its operating cash flow and capital expenditures.

However, if those have gone to the wayside, the formulas you could use in a pinch are:

•   (Net Operating Profit – Taxes) – Net Operating Capital Investment = Free Cash Flow

•   Sales Revenue – (Operating Costs + Taxes) – Operating Capital Investments = Free Cash Flow

Free Cash Flow Example

Let’s revisit the fictional company XYZ Retail.

At the end of July, XYZ Retail’s total operating cash flow was $187,500.

That same month, they made upgrades to their building to make it more ADA accessible. This would be a capital expenditure because those upgrades are permanent and can help with future success. The total capital expenditure amount was $53,050.

As the formula for free cash flow is:

Operating Cash Flow – Capital Expenditures = Free Cash Flow

XYZ Retail’s formula would be:

$187,500 – $53,050 = $134,450

This means the free cash flow is $134,450.

Cash Flow Forecast Formula

Calculating your cash flow forecast can help you plan month to month, quarter to quarter, or year to year by figuring out approximately how much money you’ll have on hand.

Remember: Just like weather forecasting, cash flow forecasting isn’t a perfect science. You never know when the winds may change. So, it may be wise to be conservative in your estimates.

Forecasting cash flow is more complex than operating and free cash flows, as you need more details.

There are two methods of cash flow forecasting: Direct and indirect.

To calculate direct cash flow, take the following steps:

1.    Determine cash in.

2.    Determine cash out.

3.    Subtract cash out from cash in.

4.    Do this month over month to make an educated guess for the coming months.

5.    Cash flow can wax and wane depending on the season. Therefore, something like a summer-only direct cash flow amount may not apply to the winter.

While this seems simple on the surface, this isn’t necessarily the case. You need to know precisely where all money is coming and going from. (Luckily, you can set up a spreadsheet to keep track of it, but you should update it frequently to ensure nothing gets missed.)

The indirect method of calculating cash flow forecast focuses on net income and factors affecting profitability — but not cash balance. It uses your profit and loss statements and balance sheet. To use this method, follow these steps:

1.    Get your current balance from your balance sheet. If you have previous ones, check those as well.

2.    Compare it to your profit and loss statements to get a decent estimate of your monthly cash in and cash out.

This method is more commonly used among people who don’t want to hire a bookkeeper or use accounting software or those with so many transactions that monitoring every single one is difficult.

Neither method is right or wrong; try out both to see which works best for you.

Cash Flow Forecast Example

American Express provides a cash flow forecast template , as well as an example of what it might look like:

Discounted Cash Flow Formula

Discounted cash flow (DCF) estimates the future value of a business based on projected cash flows. It can help determine whether an investment is likely to pay off in the long run.

The term “discounted” is there to account for inflation and the lower value of money received in the future compared to money received now.

The discount rate is usually a company’s weighted average cost of capital (WACC), which represents how much a company must pay to its investors and lenders.

(Note: The discount rate can also be an interest rate. It depends on the type of investment.)

The discounted cash flow formula looks like this:

CF = Cash flow

r = Discount rate

Discounted Cash Flow Example

Let’s put this into an example.

A potential investor in XYZ Retail wants to determine if they’ll see return on investment in three years if they invest $50 million now.

Let’s say XYZ’s cash flow (CF) for Year 1 is $20 million. Based on past performance, we calculate that future cash flow is expected to grow at a rate of 5% each year. So, for Year 2, CF will be $21 million and Year 3, CF will be $22.05 million.

Now, let’s say the WACC for XYZ Retail is calculated to be 4%, meaning 0.04 will be our discount rate (r).

Plugging it into the equation, we find:

DCF = 19,230,769.23 + 19,415,680.47 + 19,601,742.37

DCF = $58,248,192.07

In this case, the investor may see a return on their investment of $50 million in three years. However, it is very important to remember that DCF relies heavily on forecasting, meaning it is not going to be 100% accurate — or a 100% guarantee of a company’s future value.

It may be easier to use a template and/or accountant to make these calculations. There are free, pre-built templates on the web, including one from the Corporate Financial Institute , that may help with calculating DCF.

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Managing Cash Flow Problems

When handling business cash management, many companies experience cash flow hiccups. Frequently tracking and analyzing your finances can help you anticipate challenges and create proactive solutions.

Using Accounting Software

While calculating cash flow by hand is great, accounting software can help you keep a closer eye on where money is coming from and going to. For instance, these programs can create invoices and track outstanding ones. They can also automatically break down expenses compared to actual cash brought in each month.

Hiring a Bookkeeper

A bookkeeper or accountant can bring to this the human touch that accounting software can’t. For instance, this professional can analyze the information, then break down the data into layman’s terms.

Small companies may not want or be able to invest in a full-time staff member, but some people do this on a part-time, freelance, or contract basis.

Refining Your Budget

Constantly analyze and refine your cash flow to ensure you have an effective operating budget in place. This can help businesses weather potential or anticipated downturns in business.

Increasing Revenue

Increasing revenue during a period of negative cash flow may require thinking outside of the box.

This might include running an alternative marketing campaign, expanding employee training, and finding creative ways to turn over inventory that isn’t selling well.

Applying for a Line of Credit

Depending on the nature of your cash flow issues and how long you expect them to last, applying for a business line of credit may be an option for getting an injection of capital. This is typically best used if you know what the problem and solution are and need a temporary fix.

Just like with any type of financing, however, you’ll want to make sure you have a solid plan to repay your balance.

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Other Important Financials to Know About

Your business’s cash flow statement is one of many critical financial snapshots reflecting your company’s health. However, there are other ways of monitoring financials, including balance sheets and income statements.

Balance Sheet

Your company’s balance sheet also holds a lot of valuable information, including assets, liabilities, and details on owners/shareholders.

Assets include cash, inventory, and property.

Liabilities include debt, expenses, and owners’/shareholders’ equity. This equity is particularly relevant if they’re paid retained earnings.

A balance sheet reveals important metrics such as your business’s debt-to-equity ratio and amount of working capital.

You typically need to provide your balance sheet any time you apply for financing or pitch to new investors, along with other documents, so it’s a good idea to have this prepared for any such occasion.

Income Statement

While your cash flow includes data from the business’s financing and investments, your income statement focuses solely on revenue and expenses over a set period. As a result, it can reveal trends in sales, production costs, and operating expenses.

Depending on the type of accounting used, the income statement may or may not be based on cash accounting.

For example, cash flow measures funds as they enter and leave your business accounts. But using an accrual accounting method, your income statement would reflect when orders are placed rather than paid for.

The Takeaway

Learning how to calculate cash flow is a vital step in understanding your finances.

When joined by other documents such as your balance sheet and income statement, you can use cash flow information to keep track of profitable ventures and overspending. It’s wise to regularly review your cash flow to ensure everything is running smoothly.

If you’re seeking financing for your business, SoFi can help. On SoFi’s marketplace, you can shop top providers today to access the capital you need. Find a personalized business financing option today in minutes.

Photo credit: iStock/PeopleImages

SoFi's marketplace is owned and operated by SoFi Lending Corp. See SoFi Lending Corp. licensing information below. Advertising Disclosures: SoFi receives compensation in the event you obtain a loan through SoFi’s marketplace. This affects whether a product or service is featured on this site and could affect the order of presentation. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

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Understanding key financial ratios and what they say about your business’s health is an important part of managing your business finances.

Financial ratios are tools that can help you (as well as potential investors and creditors) analyze your business’s financial activities, liquidity, growth, and profitability. They can help you make informed decisions about your business operations and how you invest and spend your money in the future. And you don’t need an accounting degree to understand them.

You can get the numbers to use for financial ratios from your business’s financial statements, including your balance sheet, cash flow statement, and income statement. But once you calculate these ratios, they can provide a bit more insight than those reports offer on their own.

Here’s a look at six of the most important financial ratios for small businesses.

1. Working Capital Ratio

What it is: One key financial ratio you may want to calculate is the working capital ratio, also called the current ratio. It’s a measurement of whether your company can easily pay short-term liabilities with its current assets.

Why it matters: If you apply for a small business loan, a lender may want to see your working capital ratio because it measures your business’s financial health and can tell them how great a risk your company presents as a borrower. For investors, it’s important to understand the liquidity of your company so they can determine how easy it might be for your business to cover debts and get to profitability.

How to calculate: The working capital ratio formula is

Current assets / Current liabilities

You’ll find the numbers you need to calculate this ratio on your balance sheet. Current assets and liabilities are usually those expected to be used or settled, respectively, within the year.

Too low a ratio indicates that you have more liabilities than assets and might be a risky investment. But a ratio that’s too high might suggest that you have money sitting in the bank, not being used to grow the company. A good working capital ratio is generally considered to be between 1.2 and 2.

Example: To take a simplified example, let’s say you own a small toy store. By way of current assets, you have $25,000 in inventory. By way of current liabilities, you owe $10,000 on a business credit card and $5,000 in other short-term debts. That means your total current liability is $15,000. To figure out your working capital ratio, you divide $25,000 by $15,000 to get 1.67.

2. Debt-to-Equity Ratio

What it is: Another financial ratio that can help you better understand your business’s liabilities and assets is the debt-to-equity (also known as debt/equity ratio). This is a measure of your company’s debt in relation to equity (or investment).

Why it matters: Your debt-to-equity ratio indicates how much risk your business runs when it comes to paying back your long-term debt. While taking on debt can help you grow your company, it shouldn’t end up costing you more than the potential growth it creates. Investors typically want to work with companies that aren’t stretched too thin because those are risky investments.

How to calculate: The debt-to-equity ratio formula is

Total liabilities / equity (or investment)

If your company has investors, you use equity for the bottom half of the equation. If it doesn’t, you use the investment that you yourself have made in your company. In terms of debt, only long-term debt (debt being repaid over more than a year) is considered.

The lower the ratio, the less risk your company presents to investors. A ratio of less than 1.0 is typically considered good.

Example: Imagine you have a small bakery. It has an outstanding business loan on which it owes $10,000 plus $5,000 that it owes on a business line of credit. It doesn’t have any shareholders, but you invested $35,000 to get the business off the ground. To find your debt-to-equity ratio, you would divide $15,000 by $35,000 to get a debt to equity ratio of 0.43.

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3. Gross Profit Margin

What it is: Another basic financial ratio you may want to look at is gross profit margin. It’s an indicator of how much profit you’re seeing after you’ve covered your cost of goods sold. Cost of goods sold (COGS) means all the direct costs that go into creating your product, including raw materials, inventory, and labor.

Why it’s important: You may have different profit margins for different products, but your business’s overall gross profit margin looks at all of them together to determine how well you’re using that profit in your company. Put another way, your gross profit margin is a measure of how profitable your company is.

How to calculate: The gross profit margin formula is

Net sales / (Net sales – COGS)

This ratio is generally multiplied by 100 and expressed as a percentage

To find your gross profit margin, you’ll first need to know your cost of goods sold, as well as your net sales.

A higher number is typically viewed as better than a lower number, but what constitutes a good gross profit margin varies by industry. Manufacturers of electrical equipment, for instance, average a gross profit margin of 35%. Grocery stores, on the other hand, average a gross profit margin of 25% to 30%.

Example: Let’s say your small business’s net sales are $10,000 a month. Additionally, we’ll imagine that it cost you $5,000 in direct costs to make your inventory for a month. To calculate your gross profit margin:

(10,000-5,500) / 10,000 =

5,500 / 10,000 = 0.5

Multiplying this by 100, we arrive at 50%.

4. Cash Ratio

What it is: Cash ratio paints a picture of your company’s liquidity. It looks at cash and cash equivalents (assets that can be quickly transferred into cash, like savings accounts) as well as current liabilities (debts due within the year) to demonstrate how easy it would be for your company to pay off all its liabilities without liquidating assets.

Why it matters: Creditors care about your cash ratio because it tells them the value of your current assets that could, if necessary, be converted into cash to cover liabilities. It’s a fairly conservative financial ratio compared to others because it only considers cash or cash-equivalent assets and not other assets like accounts receivable or real estate.

How to calculate: The cash ratio formula is:

(Cash + cash equivalents) / Current liabilities

In general, a higher ratio is deemed better than a lower one since it suggests that the company can probably pay off its debt with relative ease. While there’s no official cutoff, a ratio above 0.5 to 1.0 is generally thought to be good.

Example: Let’s imagine you own a bakery. It has $10,000 in a business checking account, plus $12,000 in equipment and supplies. It also has short-term business debt amounting to $10,000 plus a mortgage on the building the business is in for $150,000. To figure out your cash ratio you would divide $10,000 by $10,000, giving you a ratio of 1.0. (Remember, you’re only dealing with short-term debt and assets you can easily and quickly transfer into cash to pay it off. Therefore the mortgage, which is long-term debt, and the equipment and supplies, which may not be easy to turn into cash, don’t factor into the equation.)

Recommended: Debt to EBITDA Ratio

5. Inventory Turnover Ratio

What it is: If you sell products, this is a useful ratio because it looks at how quickly your company sells and turns over inventory each year.

Why it matters: You may have some products that aren’t selling well, and this calculation will direct you to the ones that you might want to stop making in favor of more popular (and profitable) products. The higher your inventory turnover ratio, the higher your sales volume.

How to calculate: The inventory turnover ratio formula is

Cost of goods sold / Average inventory

You may want to compare inventory turnover from one point in time to another and then average the inventory costs from the beginning and end of that period.

A higher number is generally considered better than a lower one, since it suggests a high turnover rate for your product. But what number is specifically considered good varies by industry.

Example: For the year 2020, your small fan production company has a COGS of 100,000. Your average inventory for the year amounts to $25,000. To find your inventory turnover ratio, divide $100,000 by $25,000. Your ratio is 4.0.

6. Fixed Asset Turnover Ratio

What it is: In your business, you have what are called fixed assets. These are assets like commercial property, machinery, equipment, and commercial vehicles. These fixed assets should be helping you make more money. And that’s what the fixed asset turnover ratio calculates: how well you’re leveraging these fixed assets to increase your revenues.

Why it matters: A low fixed asset turnover ratio may indicate that your company has over-invested in fixed assets that aren’t generating an appropriate amount of revenue.

How to calculate: Here’s the formula for fixed asset turnover ratio

Net sales / Average fixed assets

A higher rate is usually seen as better, as it suggests that your business is getting value from its fixed assets. However this ratio can vary enormously, so there’s no one yardstick to measure what a good fixed asset turnover ratio is. The ratio may be most useful when you’re comparing your company’s use of its fixed assets over time or when you’re comparing your company against its industry as a whole.

Example: If your small business pet toy company had net sales in 2020 of $150,000 and had an average fixed asset total of $50,000 (that you’d invested in machinery), your fixed asset turnover ratio would be 3.0.

Recommended: How Much Does It Cost to Start a Business?

What Is Ratio Analysis?

You and your potential investors can use financial ratios to analyze the data in your financial statements and glean information that goes beyond what those statements tell you straight out. This is called financial ratio analysis.

Typically, you’d use spreadsheet or ratio analysis software to calculate the financial ratios most important to you on a quarterly basis. You can compare the ratios you get with the last quarter or with the same quarter in previous years to spot trends.

Sometimes, it may be helpful to compare your ratios to those of other companies in your industry. That can help you gain a good understanding of your company’s performance. You may want to run analyses on several types of financial ratios to get the full picture of your business’s financial wellbeing.

As the owner of your company, you’ll want to stay on top of your financial ratio analysis. If you have a financial manager or investors, they may also want access to this data on your key financial ratios.

How and When to Conduct Analyses

Using financial ratios can be helpful if:

•   You want a snapshot of your business’s performance. This could be because you just want a benchmark or because you’re considering a big move like selling the company.

•   You’re looking to take on investors or apply for a business loan. In these cases, your investors or creditors may request certain financial ratios to determine how much of a risk your company presents to them.

•   You’re curious about where your business stands in relation to others in your industry.

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Pros and Cons of Working With Financial Ratios

Using financial ratios can help you make better decisions about the future of your business and how it uses capital. Being able to look back at your company’s performance over time can give you (and investors) a good sense of its general financial wellbeing and predict future growth. If the numbers haven’t been good, you can make decisions that put the business back on course for success.

Pros of Working With Financial Ratios

You may also be able to identify trends when you compare your business’s ratios from one time period to another. For example, if Q4 ratios are always positive, it could be an indicator that sales tend to be particularly high that quarter, and you can plan to leverage that fact accordingly.

Calculating your business’s financial ratios and then comparing them to those of others in your industry can give you an understanding of where your company fits among its peers.

And if you’re looking to bring on an investor, having these financial ratios available gives him or her a clear understanding of what kind of risk your company represents as an investment.

Recommended: Microloans for Women Owned Businesses

Cons of Working With Financial Ratios

On the other hand, financial ratios don’t always account for economic conditions. If there’s been a period of inflation, comparing numbers from one period to another may not paint an accurate picture, and the same thing is true if there’s a period of economic decline.

Additionally, it can be trickier than you’d think to compare your ratios to industry numbers. Many companies may be tempted to fudge their ratios to make their businesses look more successful than they are, so it may be challenging to get a real apples-to-apples comparison.

The Takeaway

No matter why you’re considering your financial ratios, congratulations. You’re one step further in owning your business’s financial wellbeing. The more you know about your finances, the better informed you are to make decisions to help your company grow over time and to attract investors as a lucrative investment.

If you’re seeking financing for your business, SoFi can help. On SoFi’s marketplace, you can shop top providers today to access the capital you need. Find a personalized business financing option today in minutes.

Photo credit: iStock/pixdeluxe

SoFi's marketplace is owned and operated by SoFi Lending Corp. See SoFi Lending Corp. licensing information below. Advertising Disclosures: SoFi receives compensation in the event you obtain a loan through SoFi’s marketplace. This affects whether a product or service is featured on this site and could affect the order of presentation. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

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There are 604,176 small businesses in Maryland, accounting for 99.5% of all businesses in the state. Collectively, Maryland’s small business owners employ over 1.2 million individuals, which represents nearly half of the state’s private workforce.

A large portion of Maryland’s small businesses are concentrated in the professional, science, and technology industries, thanks to the proximity to government agencies that offer grants and contract money for scientific research and studies. However, there are Maryland grants available for small and midsize businesses in a wide range of industries.

Here’s a look at five grants you may want to check out, plus other ways to find business funding.

Grants for Small Businesses in Maryland

If you’re looking for a small business grant to grow or start your business in Maryland, here are some options to consider.

Partnership for Workforce Quality (PWQ) Grants

•   Program description: The PWQ program provides eligible small and midsized manufacturing and technology companies with matching grants to train employees in new technologies and production processes.

•   Incentive: Receive matching grants of between $10,000 and $200,000 to reimburse up to 50% of the costs of qualified projects.

•   General requirements:

◦   Be a Maryland-based employer

◦   Have at least 10 full-time employees

◦   Be current on your state tax obligations and not in default with any Maryland Department of Commerce program

◦   Priority will be given to manufacturing and technology companies

•   How to apply: Contact your Maryland Department of Commerce regional representative to apply for PWQ funding.

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Build Our Future Grant Pilot Program

•   Program description: The Build Our Future Grant Pilot Program provides Maryland-based private companies with grants for infrastructure projects intended to support innovation in an eligible technology sector.

•   Incentive: Receive up to $2 million in a fiscal year and use the funds for an eligible infrastructure project in select industries, including advanced manufacturing, artificial intelligence, cybersecurity, and life sciences.

•   General requirements:

◦   Be a Maryland-based company in good standing with the state

◦   Propose an infrastructure project that advances innovation and growth in an eligible technology sector

◦   For a grant award up to $1 million, you provide matching funds that are at least 200% of the grant amount

◦   For a grant award exceeding $1 million and up to $2 million, you must provide matching funds that are at least 400% of the grant amount

•   How to apply: You can submit your application on the Build Our Future Grant Pilot Program’s website. Funding for 2024 is closed. Applications for 2025 funding will be accepted starting in the Fall of 2024.

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ExportMD Program

•   Program description: The ExportMD Program can reimburse some of your international marketing expenses if you own and operate an eligible Maryland small or midsize business.

•   Incentive: Receive up to $5,000 in reimbursement for eligible business expenses,, including the cost of travel related to international marketing, website development, and registration costs for virtual trade shows.

•   General requirements:

◦   Be an established Maryland business in operation for at least 12 months

◦   Be in good standing with the Maryland Department of Assessments and Taxation

◦   Meet the federal definition of small business for your industry

◦   Be planning an international business initiative to commence and conclude within six months of the application deadline

◦   Recipients of the ExportMD grant in the last yea​r are not eligible

•   How to apply: Contact the Maryland Department of Commerce if you’re interested in the ExportMD Program.

Maryland Agricultural & Resource-Based Industry Development Corporation (MARBIDCO) Grants

•   Program description: MARBIDCO offers several grant incentive programs for farm, forestry, and seafood businesses, including the Resilient Food Systems Infrastructure (RFSI) Matching Grant Program. The RFSI grant supports expanding capacity for the growing, processing, manufacturing, and distribution of locally and regionally produced food products,

•   Incentive: Eligible farmers can receive from $10,000 to $100,000 to purchase equipment or $100,000 to $3 million to fund capital investments.

•   General requirements:

◦   Be an agricultural marketing group or legally organized farm cooperative including at least four Certified Local Farm and Certified Chesapeake Invasive Species Providers

◦   Be a wholesale distributor that is selling to at least one institution and aggregating from at least four Certified Local Farm and Certified Chesapeake Invasive Species Providers

◦   Propose a project that meets all RFSI application requirements

•   How to apply: Contact MARBIDCO to find out about and apply for any available grant programs.

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Maryland Manufacturing 4.0 Grant Program

•   Program description: ​The Maryland Manufacturing 4.0 grant program provides matching funds to small and midsized Maryland manufacturers to adopt new technologies and digital business practices.

•   Incentive: Eligible manufacturers can receive $25,000 to $500,000 in matching grants for the purpose of implementing a proposed modernization project.

•   General requirements:

◦   Be an existing business in good standing with the state of Maryland

◦   Company has operated for at least three years

◦   Be a manufacturing sector employer under the North American Industry Classification System (NAICS)

◦   Have between three and 250 total full-time employees

◦   Be in good standing with federal Occupational Safety and Health Administration and Maryland Occupational Safety and Health regulations

◦   Demonstrate an ability to implement a proposed modernization project

◦   Demonstrate your ability to meet the matching funds requirement

•   How to apply: Download the Maryland Manufacturing 4.0 Grant application on the state Department of Commerce website and apply during an open grant period.

Who Provides Small Business Grants in Maryland?

State and local government agencies, including the Maryland Department of Commerce, offer a variety of small business grants in the Old Line State.

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Do You Have to Pay Back a Small Business Grant?

Generally, no. Unlike small business loans, you usually do not need to repay the funds you receive through a small business grant. That said, small business grants typically come with terms and conditions, and you may be responsible for paying back the grant if you violate those terms.

You typically have to sign a funding agreement to accept a small business grant. Using the grant for an illegitimate purpose may violate the agreement and require business owners to pay back the grant.

In addition, small business grants may require you to spend the money by a certain date. You may also have to provide proof of payment and a written statement detailing how you’ve spent the grant.

Who Is Eligible for Small Business Grants in Maryland?

Local business owners or operators of an enterprise with fewer than 500 employees may be eligible for small business grants in Maryland.

The U.S. Small Business Administration’s Office of Advocacy generally defines a small business as an independent business having fewer than 500 employees. A small business with just a few employees, even self-employed individuals, may be eligible for small business grants.

What Industries Does Maryland Support With Grants?

Maryland offers grants supporting a variety of business sectors, including:

•   Advanced manufacturing

•   Aerospace

•   Agriculture

•   Artificial intelligence

•   Biotechnology

•   Blue technology

•   Cybersecurity

•   Defense

•   Energy and sustainability

•   Life sciences

•   Manufacturing

•   Quantum

•   Sensors and robotics

Maryland Resources for SMB Owners Looking for Funding

Here are some resources for small and medium-sized businesses looking for funding in the Old Line State.

Maryland Small Business Development Center (SBDC)

The Maryland SBDC is a statewide program that can provide Maryland’s small business owners with the following services at no cost:

•   Access to customized research reports

•   Individualized business consulting

•   Online and in-person training events for Maryland small business owners

SBA District Office in Maryland

The U.S. Small Business Administration (SBA) is a federal agency that provides resources and support to small business owners. The SBA has two district offices in Maryland:

•   SBA Baltimore District Office. This SBA district serves Baltimore City and all Maryland Counties, except for Montgomery and Prince George’s counties.

•   SBA Washington Metropolitan Area District Office. This SBA district serves the District of Columbia, two counties in Maryland (Montgomery and Prince George’s), and three counties in Northern Virginia (Arlington, Fairfax, and Loudoun, plus the cities of Alexandria, Fairfax, and Falls Church).

Alternative Funding Sources for Small Businesses in Maryland

If you don’t qualify for small business grants in Maryland, you’re not necessarily out of funding options. Here are some other ways you may be able to get the capital you need to launch or grow your business in Maryland.

Maryland Microloan Lenders

Community-based nonprofits may offer microloans of anywhere from $500 to $50,000 to underserved small business owners in Maryland, such as women and minorities. Interest rates tend to be low (or zero in some cases), and the qualification criteria are often less stringent compared with other business loans.

Microloans can provide an infusion of cash to get a startup off the ground or grow an existing business. However, you may need to provide a microlender with a personal guarantee and collateral in order to secure funding.

Maryland SBA Loans

The U.S. Small Business Administration (SBA) offers a range of loan programs to help small businesses secure funding. These loans are partially guaranteed by the SBA, which reduces risk for lenders and increases accessibility for businesses. The 7(a) loan program is one of the most popular, providing funds for working capital, equipment purchases, and debt refinancing. SBA loans typically offer longer repayment terms and lower interest rates compared to conventional business loans.

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Maryland SMB Term Loans from Private Lenders

Many banks, credit unions, and online lenders in Maryland offer term loans to small businesses. Online alternative lenders often have more flexible eligibility criteria than traditional banks, making them a good option for businesses that are just starting out. However, interest rates tend to be higher.

With term loans, you receive a lump sum of money up front then repay it over a set period of time, often with a fixed interest rate. You can use the funds for various purposes, including business expansion, buying equipment, and working capital.

Recommended: What to Know About Short-Term Business Loans

Business Lines of Credit

A business line of credit provides businesses with flexible access to funds up to a predetermined limit. Unlike traditional loans, a line of credit allows businesses to borrow only what they need, when they need it. This flexibility can be helpful for managing cash flow, covering unexpected expenses, and taking advantage of growth opportunities.

Business lines of credit typically have variable interest rates and can be secured or unsecured, depending on the lender and the borrower’s creditworthiness.

Equipment Financing

Equipment financing is specifically designed to help businesses acquire necessary equipment. The equipment itself serves as collateral for the loan, making approval easier. This type of financing can be used to purchase machinery, vehicles, technology, and other essential equipment. Terms for equipment financing vary based on the lender and the type of equipment, but generally feature fixed interest rates and repayment terms from three to ten years.

The Takeaway

If you’re seeking financing for your business, SoFi can help. On SoFi’s marketplace, you can shop top providers today to access the capital you need. Find a personalized business financing option today in minutes.

Frequently Asked Questions

How do you get a small business grant in Maryland?

To find a small business grant in Maryland, you might start by contacting the state’s Economic Development Administration and your local Small Business Development Center. You typically need to submit a grant application as a qualified small business owner to be considered for a small business grant in Maryland.

How hard is it to get a business loan in Maryland?

You typically need to have been in business for at least two years and have strong financials to qualify for a business loan from a bank. Online alternative lenders tend to have more flexible qualification criteria for small business loans but generally charge higher interest rates.

What is the easiest SBA loan to get approved for?

There’s no guarantee you’ll get approved for any SBA loan, but SBA microloans may be one of the easier ones to get if you’re a new business owner. Startups may be eligible for SBA microloans of up to $50,000. If you’re looking for a streamlined application process, you may want to look into an SBA Express loan.

Photo credit: iStock/RgStudio

SoFi's marketplace is owned and operated by SoFi Lending Corp. See SoFi Lending Corp. licensing information below. Advertising Disclosures: SoFi receives compensation in the event you obtain a loan through SoFi’s marketplace. This affects whether a product or service is featured on this site and could affect the order of presentation. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.

Third-Party Brand Mentions: No brands, products, or companies mentioned are affiliated with SoFi, nor do they endorse or sponsor this article. Third-party trademarks referenced herein are property of their respective owners.

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