Why ratios rather than absolute figures?
A profit of 300,000 SAR may be excellent for a business with sales of one million, and weak for a business with sales of twenty million. Financial ratios turn figures into indicators that can be compared with the business's previous years and with similar businesses in the same activity.
We will use the figures of a building materials company for 2025 (in SAR):
| Item | Amount |
|---|---|
| Net sales | 3,000,000 |
| Cost of sales | 2,100,000 |
| Gross profit | 900,000 |
| Net profit | 295,000 |
| Cash | 150,000 |
| Accounts receivable (opening / closing) | 340,000 / 400,000 |
| Inventory (opening / closing) | 450,000 / 600,000 |
| Current assets | 1,200,000 |
| Current liabilities | 800,000 |
| Total liabilities | 1,200,000 |
| Equity | 800,000 |
Liquidity ratios: can you pay?
Current ratio
Current assets ÷ current liabilities = 1,200,000 ÷ 800,000 = 1.5 times. For every 1 SAR due within a year, there is 1.5 SAR of current assets.
Quick ratio
(Current assets - inventory - prepayments) ÷ current liabilities. Assuming prepayments of 50,000: (1,200,000 - 600,000 - 50,000) ÷ 800,000 = 0.69 times. This means the business cannot pay its near-term liabilities without selling part of its inventory, which calls for monitoring.
Profitability ratios: is the activity worthwhile?
- Gross profit margin = 900,000 ÷ 3,000,000 = 30%.
- Net profit margin = 295,000 ÷ 3,000,000 = 9.8%.
- Return on equity = 295,000 ÷ 800,000 = 36.9% (on the closing balance; using the average balance is more accurate).
If the gross profit margin holds steady and the net margin falls, the problem lies in operating expenses or financing, not in pricing.
Activity ratios: how fast does working capital turn over?
Inventory turnover
Average inventory = (450,000 + 600,000) ÷ 2 = 525,000 SAR.
Turnover = cost of sales ÷ average inventory = 2,100,000 ÷ 525,000 = 4 times a year.
Days in inventory = 365 ÷ 4 = about 91 days. Goods stay about three months before they are sold. In an activity such as pharmacies or foodstuffs, the acceptable figure would be much lower, and in spare parts it may be higher.
Collection period
Average accounts receivable = (340,000 + 400,000) ÷ 2 = 370,000 SAR.
Collection period = average accounts receivable ÷ net sales × 365 = 370,000 ÷ 3,000,000 × 365 = about 45 days.
If the sales terms are 30 days, customers are paying two weeks late on average. It is more accurate to calculate it on credit sales only if a large part of sales is in cash.
Debt-to-equity ratio
1,200,000 ÷ 800,000 = 1.5. Creditors finance more than the owners do, which is a level at which banks pause when a new financing request comes in.
How do you actually use these ratios?
- Calculate them every quarter and put them in a single table, because the trend matters more than any single figure.
- Link them together: 91 days of inventory + 45 days of collection = 136 days from purchase to cash. If suppliers give you only 60 days, you are financing 76 days out of your own pocket.
- Compare with businesses in your own activity, not with general averages.
The ratio dashboard on one page
| Ratio | Formula | Result |
|---|---|---|
| Current | Current assets ÷ current liabilities | 1.5 times |
| Quick | (Current assets - inventory - prepayments) ÷ current liabilities | 0.69 times |
| Gross profit margin | Gross profit ÷ net sales | 30% |
| Net profit margin | Net profit ÷ net sales | 9.8% |
| Return on equity | Net profit ÷ equity | 36.9% |
| Inventory turnover | Cost of sales ÷ average inventory | 4 times (91 days) |
| Collection period | Average accounts receivable ÷ sales × 365 | 45 days |
| Debt to equity | Total liabilities ÷ equity | 1.5 |
The overall reading for this business: good profitability and a high return on the owners' funds, but part of that high return comes from reliance on debt, and quick liquidity is weak because inventory stays for three months. Management's priority is not to increase sales, but to speed up inventory turnover and customer collections, because every 15 days cut from the inventory period frees up about 86,000 SAR of cash (2,100,000 ÷ 365 × 15).
By the same logic, every 10 days cut from the collection period frees up about 82,000 SAR (3,000,000 ÷ 365 × 10). These are figures the owner understands immediately, and they make a sound basis for clear quarterly targets for the purchasing and collection teams, instead of general targets such as “improve liquidity”.
If this is your first time, start with only two or three ratios, then add the rest gradually.