Why Ratios Matter

Financial statements give data; ratios give meaning.
They show how efficiently SweetBite Bakery and TechNova Solutions turn money into results.

Accounting records performance. Ratios explain performance.
Profit vs Efficiency vs Return
Three dimensions every founder must know:

  1. Profitability – How much value each pound of sales creates.
  2. Efficiency – How well resources are used.
  3. Return – How effectively owners’ money grows.

Profitability Ratios – “How Much Do We Earn Per Sale?”

Ratio                             Formula                                         SweetBite Bakery Example              TechNova Solutions Example           Interpretation
Gross Margin           | (Revenue – COGS) / Revenue | (£18 000 – £7 000) / £18 000 = 61 % | (£25 000 – £3 000) / £25 000 = 88 %  | Bakery has smaller margin because ingredients cost more.
Operating Margin  | Operating Profit / Revenue    | £3 000 / £18 000 = 17 %                      | £8 000 / £25 000 = 32 %                      | TechNova spends more on growth but remains efficient.
Net Profit Margin  | Net Income / Revenue             | £2 500 / £18 000 = 14 %                      | £7 500 / £25 000 = 30 %                      | Each £1 of sales creates £0.14 or £0.30 of profit.

Visual Concept

Revenue → Costs → Profit Stack
A vertical bar shows:
  • Blue = Revenue
  • Red = Costs
  • Green = Profit

The smaller the red portion, the stronger the margin.
3 types of margins
3. Efficiency Ratios – “How Well Do We Use Our Assets?”
efficiency_ratios.jpg 32.8 KB
Ratio                               Formula                                                           Example                                             Meaning
Asset Turnover          | Revenue / Total Assets                              | £18 000 / £9 000 = 2.0×                  | Each £1 of assets creates £2 sales.
Inventory Turnover  | COGS / Average Inventory                       | £7 000 / £1 400 = 5×                        | Stock replaced 5 times per year.
Receivables Days       | (Accounts Receivable / Revenue) × 365 | £2 000 / £18 000 × 365 = 41 days | Time customers take to pay.

SweetBite: must keep ingredients fresh → fast inventory cycle.
TechNova: sells subscriptions → no physical stock, but receivables may delay cash.
Cash → Assets → Sales → Back to Cash
4. Return Ratios – “How Well Do We Reward Investment?”

Ratio                                             Formula                                    Example                                                 Meaning
Return on Assets (ROA)         | Net Profit / Total Assets       | £2 500 / £9 000 = 28 %                      | Efficiency of asset use.
Return on Equity (ROE)          | Net Profit / Owner’s Equity | £2 500 / £5 000 = 50 %                      | Return earned for the founder’s money.
Return on Investment (ROI) | (Gain – Cost) / Cost               | (£10 000 – £8 000) / £8 000 = 25 % | Evaluate new projects.
High ROE is good — but only if it’s sustainable (not built on excessive debt).

5. SweetBite vs TechNova Snapshot

MetricSweetBiteTechNovaKey Insight
Gross Margin     | 61 %  | 88 % | TechNova has lower direct costs.
Asset Turnover  | 2.0×   | 0.9× | Bakery’s physical assets work harder.
ROE                     | 50 %  | 42 % | Similar returns – different paths.
Lesson: Physical vs digital models balance cost efficiency and scalability differently.

Two Bars per Ratio Comparison
6. Common Mistakes

  1. Comparing across industries – bakery vs software have different benchmarks.
  2. Ignoring cash timing – profit ≠ cash; ratios don’t show liquidity.
  3. Focusing on one ratio – always interpret as a system.
  4. Not updating data – use rolling averages, not one snapshot.

7. How to Use Ratios in Your Startup

  • Track them monthly → spot trends early.
  • Combine financial and operational KPIs.
  • Link dashboard colors (🟦 Profitability, 🟩 Efficiency, 🟧 Return).
  • Include auto-alerts in your Startup Builder App:

    • e.g., “Gross Margin below 40 % → review pricing.”

8. The Formula to Remember

Profitability  =  Performance
Efficiency     =  Speed
Return         =  Reward
Together they define financial health.

9. Takeaway

Ratios don’t replace intuition — they sharpen it.
They turn accounting data into a navigation system for founders.

Understand them once — and you’ll read any company’s story in minutes.