How to Use Bookkeeping to Inform Your Small Business Strategy for 2025

It’s hard to think about your small business strategy when you’re overwhelmed by unpaid invoices, back-to-back client appointments, and year-end targets. We sometimes associate strategies with conference rooms, financial advisors, and elaborate charts. But did you know you already have a great strategy resource on your desk? Yes, we’re talking about your financial books.

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In this article, you’ll learn how your bookkeeping data can be used to analyze your financial health, identify emerging trends, and evaluate your budget performance. You’ll learn how to maximize this information to develop your strategies confidently.

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Calculate Key Indicators to Evaluate Your Financial Health

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Your business transactions can give you a clear picture of your financial situation. It can highlight areas where you’re doing well, such as keeping debts low, and show you where you need to improve, such as reducing production costs.

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Here are some important financial metrics that you can calculate using your bookkeeping data:

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Liquidity

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Liquidity measures your ability to pay short-term financial obligations or liabilities (typically due within a year), such as loan payments and daily operations. It shows you if you have a positive cash flow, meaning you have more money coming in than going out. Your Cash Flow Statements are a good starting point for this information.

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Below are the key indicators for assessing liquidity:

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• Cash Ratio, or the cash asset ratio, shows how well your business can pay its short-term obligations with cash or cash equivalents (investments that can be quickly converted to cash). The formula is: Cash Ratio = (Cash + Cash Equivalents) / Current Liabilities. If the ratio is less than 1, you have insufficient cash to fully cover your short-term obligations. However, a very high ratio might indicate an inefficient use of the cash and cash equivalents.
• Quick Ratio, often called the acid-test ratio, looks at how well your cash equivalents or near-cash assets can pay your short-term obligations without the need to sell inventory or get external funding. The formula is: Quick Ratio = Quick Assets / Current Liabilities. To determine your Quick Assets, subtract your inventory and prepayments from your current assets. Inventory is included because it can’t be quickly converted to cash. If the Quick Ratio is less than 1, you might not be able to pay off your liabilities. However, this ratio needs to be analyzed in the context of the industry average and the company's specific operational needs.
• The Current Ratio shows how well all your current assets, such as cash, inventory, and accounts receivable, can pay off your current or short-term liabilities defined as due within one year. The formula is: Current Ratio = Current Assets / Current Liabilities. Like the other liquidity ratios, a good result is at least 1. A higher ratio greater than 1 might suggest that the company needs to be using its current assets efficiently or managing its working capital effectively.

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Profitability

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Profitability measures net income to the company’s size. It shows how well the company can sustain its operations and whether it has the capacity to expand. This is crucial because, according to a 2023 study, small and micro businesses are planning to prioritize global growth.

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Your Profit and Loss Statements can help you determine your profitability. Below are the key indicators.

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• Net Profit/Income Margin shows a business's net profit as a percentage of total revenue. Net Profit, or “the bottom line,” is your profit minus all your business costs and expenses. It measures how efficiently you’re running your entire operations. The formula is: Net Profit Margin = (Net Profit / Total Revenue) X 100.
• Gross Profit/Income Margin reveals how much of the total revenue is profit after accounting for the cost of goods sold (COGS), which includes all direct costs associated with a company's production of goods. The formula is Gross Profit Margin = (Total Revenue—COGS) / Total Revenue X 100. This formula calculates what percentage of each dollar of revenue is retained as gross profit, showing how well a company controls its production costs.

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Contextual Understanding

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It is essential to note that both margins can vary widely by industry. For example, retail businesses typically have lower net profit margins than technology companies due to differing business models and cost structures. Therefore, profit margin comparisons should be made within the same industry to get a more accurate benchmark.

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Operational efficiency

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Operational efficiency shows how well you use your resources–such as labor, equipment, and technology–to maximize output without compromising quality and productivity. Achieving high operational efficiency means making the most out of every dollar spent on these resources, which can lead to increased profitability.

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Here are some of the indicators:

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• Cost of Goods Sold (COGS) is the cost of producing, selling, and distributing a product, including labor, material, and shipping expenses. This does not include other indirect expenses, also called overhead, such as sales efforts and marketing campaigns. The formula is: COGS = Starting Inventory + Purchases - Ending Inventory. If COGS increases, without a proportional sales increase, net income will decrease because it represents higher costs being incurred.
• Operating Margin measures how well the company generates revenue through its core operations. The formula is Operating Margin = Operating Earnings (or Earnings Before Interest and Taxes, EBIT) / Revenue. A higher operating margin indicates that the company is managing its operational costs well, generating more earnings per dollar of revenue.

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Debt level or capacity

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Debt capacity shows how much debt a business can have and consistently pay off. More debt indicates that a company needs to be managing its finances better. The Balance Sheet provides essential data for evaluating your business's debt levels to its assets.

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Here are some debt level indicators:

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• Debt Ratio measures how much a company’s assets are funded by debt. A ratio that exceeds 1 means that your business has more debts than assets. The formula is: Debt Ratio = Total Debt / Total Assets.
• Debt-To-Equity Ratio shows how much of your financing comes from debt versus investor funds or equity. A low ratio means you’re not heavily relying on debt to fund your business. The formula is: Debt-to-Equity Ratio = Total Liabilities / Shareholder Equity.

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While a higher debt ratio or debt-to-equity ratio can indicate financial risk, these ratios should be interpreted within the context of the industry and the current economic conditions. Some industries naturally operate with higher leverage.

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Identify Trends & Patterns

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Your sales and expenses can highlight trends that need to be enhanced or addressed. For example, a particular product or service is more in demand during certain months. You can prepare in advance by ensuring adequate inventory or hiring independent contractors during peak seasons.

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Meanwhile, your Net Profit can tell you if your pricing is adequate or needs to be adjusted. Consider re-assessing your job costing to determine if your expenses justify your pricing. Analyze each expense category to see if costs rapidly increase or become unmanageable.

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For example, if raw material costs are surging, you can negotiate with your vendors or shop for better deals. You can also consider automating your expense management so you’re immediately notified of areas where you’re overspending.

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Analyze Your Budget Performance

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At the end of the year, go through your budget and compare it with your actual expenses. You can review each category and subtract your actuals from your budgets to see the difference. Were your allocations and forecasts correct, or would you need to adjust them for specific areas/periods?

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If there are large differences, investigate why this happened. Were these caused by internal issues or external factors like market conditions? Were there any inefficient processes?

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Ensure that you take immediate action. For example, manual entries or data consolidation push up labor costs and increase the number of unpaid invoices. In that case, consider automating your bookkeeping and invoicing processes.

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Turn Your Bookkeeping Data Into Small Business Strategy With Decimal

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Data analysis is no longer just for large companies; your small business needs it too! With Decimal’s bookkeeping services, your financial transactions are captured, recorded, reconciled, and analyzed in real-time. We also offer expense management and financial reporting, so you’ll always have accurate information anytime, anywhere.

‍Schedule a meeting with Decimal to discover how your bookkeeping can be a powerful tool for strategy.