The financial balance sheet is the main accounting document and a valuable tool that reflects a company’s real financial condition. The ability to read and interpret it helps identify potential issues and take timely action. In this article, we will explore five key financial ratios that may signal potential financial risks.
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1. Net profit margin: how profitable is your business
Net profit margin is a ratio that shows what portion of revenue the company retains as net profit after deducting all expenses, including cost of goods sold, taxes, administrative, and operating costs. It reflects overall business efficiency and the company’s ability to generate profit under its current cost and tax structure.
A low net profit margin may indicate excessive expenses, underpricing, or poor operational efficiency.
This indicator is especially important for investors and business owners, as it shows how much profit remains "in hand" for every leu of revenue.
A low net profit margin may indicate excessive expenses, underpricing, or poor operational efficiency.
This indicator is especially important for investors and business owners, as it shows how much profit remains "in hand" for every leu of revenue.
Formula:
Net profit margin = Net profit / Revenue
Optimal range: 0.05 – 0.3
How to improve the ratio:
How to improve the ratio:
- Optimize tax planning
- Reduce operational expenses
- Increase pricing strategy
2. Current ratio: can you pay your bills on time
The current ratio reflects a company’s ability to pay its short-term obligations using its current assets. It shows how balanced the company’s cash flow is and whether there is a safety buffer to cover ongoing expenses — such as rent, payroll, and supplies.
A value below 1 indicates a risk of cash gaps and the need for debt restructuring. An overly high ratio (>2) is also undesirable, as it may indicate inefficient use of working capital (e.g., excessive inventory or idle funds).
A value below 1 indicates a risk of cash gaps and the need for debt restructuring. An overly high ratio (>2) is also undesirable, as it may indicate inefficient use of working capital (e.g., excessive inventory or idle funds).
Formula:
Current ratio = Current assets / Current liabilities
Optimal range: 1 – 2
How to improve the ratio:
How to improve the ratio:
- Increase the share of liquid assets (cash, receivables)
- Reduce short-term liabilities (e.g., debt restructuring)
3. Short-term debt ratio: assessing capital shortage risks
The short-term debt ratio helps assess the structure of a company’s financing sources and its resilience to external shocks.
A high value indicates that a significant portion of capital comes from short-term obligations — loans, borrowings, accounts payable. This increases the risk of liquidity shortages in the event of sudden revenue drops or unforeseen expenses.
Monitoring this ratio helps balance the proportion between equity and borrowed funds and maintain a stable financial position.
A high value indicates that a significant portion of capital comes from short-term obligations — loans, borrowings, accounts payable. This increases the risk of liquidity shortages in the event of sudden revenue drops or unforeseen expenses.
Monitoring this ratio helps balance the proportion between equity and borrowed funds and maintain a stable financial position.
Formula:
Short-term debt ratio = Short-term liabilities / (Long-term liabilities + Short-term liabilities)
Optimal range: 0.3 – 0.7
How to improve the ratio:
How to improve the ratio:
- Reduce short-term debt
- Attract additional capital
4. Inventory turnover ratio: efficiency of warehouse management
The inventory turnover ratio shows how effectively a company uses its inventories. It measures how many times during a period (typically a year) inventory has been sold or used.
A high value indicates fast turnover and efficient inventory management. A low ratio may signal overstocking, obsolete products, or inefficient warehouse planning. This leads to excessive storage costs and reduced liquidity.
A high value indicates fast turnover and efficient inventory management. A low ratio may signal overstocking, obsolete products, or inefficient warehouse planning. This leads to excessive storage costs and reduced liquidity.
Formula:
Inventory turnover ratio = Cost of goods sold / Inventor
Optimal range: 0.2 – 2
How to improve the ratio:
How to improve the ratio:
- Analyze demand and adjust purchase volumes
- Improve inventory management
5. Debt-to-equity ratio: balancing risk and stability
The debt-to-equity ratio (also known as financial leverage) shows how heavily a company relies on borrowed capital. It measures the ratio between total liabilities and shareholder equity.
A high ratio indicates overleveraging and a higher risk of bankruptcy in case of income decline. A low ratio may indicate underutilization of financial leverage for business growth.
It is important to monitor this ratio over time and consider industry specifics when analyzing it.
A high ratio indicates overleveraging and a higher risk of bankruptcy in case of income decline. A low ratio may indicate underutilization of financial leverage for business growth.
It is important to monitor this ratio over time and consider industry specifics when analyzing it.
Formula:
Debt-to-equity ratio = Total liabilities / Total shareholder equity
Optimal range: 0.5 – 1.5
How to improve the ratio:
How to improve the ratio:
- Reduce debt burden
- Attract external investments or increase equity share
Conclusion
Regular analysis of these five financial ratios allows you to uncover hidden threats, improve your business’s financial stability, and build an effective financial management system. These indicators form the foundation for strategic decisions and help you stay in control of your company’s financial health.
Tip: Use automation tools (Excel, 1C, QuickBooks) and professional analytics to eliminate errors and make timely adjustments.
If you want to implement regular financial analysis in your company, FlagMAN-D specialists can help you build a customized performance monitoring system tailored to your business.
Tip: Use automation tools (Excel, 1C, QuickBooks) and professional analytics to eliminate errors and make timely adjustments.
If you want to implement regular financial analysis in your company, FlagMAN-D specialists can help you build a customized performance monitoring system tailored to your business.