What Financial Ratios Are Important to the Retail Industry?

Financial ratios examine relationships between important financial figures within a company's financial reporting. These ratios suggest how well a company is performing against its own history or measured against standards within its industry. As well as being internally useful, financial ratios may be important to external stakeholders, such as loan providers, investors and prospective buyers because they are indicatitive of the company's fundamental financial health.

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Within the retail industry, common financial ratios include measures such as inventory turnover and same-store sales growth.

Typically, businesses within the same industry use the same financial ratios as a basis for analysis. Performance measured by these ratios is comparable within the industry, though of less use when compared to the same ratios in other industries.

For example, inventory levels for retail businesses are usually substantially higher than those for a manufacturing company. Costs for labor are likely to be higher than in retail. As a result of these differences, financial ratios tend to vary in importance among types of businesses and industries.

Identifying the important financial ratios for a retail business involves analyzing which areas of performance are critical to success.

This may be determined internally by management philosophy or influenced by the information that external stakeholders expect to see. Ratios crucial to retail businesses examine long-term security, short-term efficiency and overall profitability. As well as overall business performance, ratios provide the means to examine pricing and inventory.

Though any financial ratio could have a bearing on retail businesses, the following five ratios tend to have special value when assessing the financial health of a retail business.

Interest on financing can cripple an otherwise successfully run business. The interest coverage ratio compares earnings before interest and taxes, called EBIT, with a company's average interest expense.

This ratio indicates how easily a company can manage interest charges from loans, rentals, equipment and other things needed to conduct business.

Lease obligations are often a hidden challenge that retailers face, and a conservative debt level indicates good interest coverage performance.

The ratio of earnings before interest and taxes (EBIT) compared with net revenue for a reporting period indicates raw profitability of the goods a company sells without factoring in expenses that aren't part of the core business.

Retailers usually operate on small margins, typically under 10 percent. A retailer with high margins compared to its competitors has much more price flexibility.

When combined with high debt loads, retail businesses with low EBIT margins are likely candidates for financial difficulties.

Dividing net sales by the average inventory balance across a reporting period gives the inventory turnover ratio. One of the fundamental business challenges of the retail industry is maintaining inventory levels that are large enough to meet customer demand without having excess inventory left over long enough to become obsolete.

Low inventory turnover typically means that cash flow may be tied up in stock that's sitting on shelves. While usually preferable, high inventory turnover levels may also indicate a retailer is not taking advantage of volume ordering discounts.

Similar to another key financial indicator called the current ratio, the quick ratio divides cash and accounts receivable by current liabilities.

The quick ratio looks only at assets that could be converted to cash quickly to pay off liabilities. It's a measure of liquidity that's generally more accurate for reflecting a retail company's financial health.

The overall health of a retail company's health and growth is revealed by same-store sales growth. This ratio looks at stores that have been open for at least a year and have past sales data.

Same-store sales should grow at least with the rate of inflation to maintain profitability with past years.

It's typically an excellent indicator when long-established stores show same store sales growth significantly ahead of inflation.