The Numbers Don't Lie—But Most Business Owners Aren't Reading Them
Here's something accountants know that most business owners don't: by the time a business "suddenly" fails, the warning signs have usually been flashing red for 12 to 18 months.
In the 2023-24 financial year alone, over 10,000 Australian companies entered external administration—a 36% increase from the year before. Construction and hospitality were hit hardest, but the truth is, no industry is immune.
What's frustrating? ASIC data shows 67% of small businesses entering insolvency had no formal cash flow forecasting system. They didn't see it coming because they weren't looking at the right numbers.
The five ratios in this guide are the same ones experienced accountants use to spot trouble early—often before the business owner feels anything is wrong. Think of them as your financial early warning system.
Why This Matters Right Now
Australian businesses are operating in one of the most challenging environments in a decade. CreditorWatch's Business Risk Index projects failure rates across all sectors to reach 5.6% in 2025—the highest levels we've seen since the GFC.
The most common causes? Inadequate cash flow (52%), trading losses (49%), and pandemic-era debt catching up with businesses. Higher interest rates, tighter margins, and cautious consumers are squeezing businesses from all sides.
The businesses that survive aren't necessarily the biggest or the best-funded. They're the ones that spot problems early and act.
Ratio #1: Gross Profit Margin (The "Check Engine Light")
What It Is
Gross profit margin measures what's left after you pay for the direct costs of delivering your product or service. It's the most fundamental measure of whether your business model actually works.
Formula:
Gross Profit Margin = (Revenue - Cost of Goods Sold) / Revenue × 100
Why It's a Warning Sign
A declining gross margin is often the first indicator that something needs attention—think of it as a "flashing check engine light" for your business.
When your margin shrinks, it means one of three things is happening:
- Your costs are rising faster than your prices
- You're discounting too heavily to win work
- Your revenue mix is shifting toward lower-margin products
The danger? Too low a gross profit margin is an existential threat to a business. When you can't cover your direct costs with healthy margins, there's nothing left for rent, wages, marketing, or—importantly—profit.
What "Healthy" Looks Like
| Industry | Typical Gross Margin |
|---|---|
| Professional services | 50-70% |
| Retail | 25-50% |
| Manufacturing | 25-35% |
| Construction | 15-25% |
| Hospitality | 60-70% (food cost ~30-40%) |
The red flag: A consistent decline over 3+ quarters—even if you're still profitable. Look for trends, not one-time dips.
What to Do
- Track monthly, not annually — Annual figures hide seasonal problems
- Break it down by product/service — One low-margin offering can drag down everything
- Compare to industry benchmarks — The ATO publishes small business benchmarks by industry
Ratio #2: Current Ratio (Can You Pay Next Month's Bills?)
What It Is
The current ratio measures whether you have enough short-term assets (cash, receivables, inventory) to cover short-term obligations (bills due within 12 months).
Formula:
Current Ratio = Current Assets / Current Liabilities
Why It's a Warning Sign
A current ratio below 1.0 means you don't have enough liquid assets to pay your bills if they all came due at once. As CPA Australia notes, a ratio below 1:1 needs attention as it may signal a shortage of funds.
The insidious part? A deteriorating current ratio often sneaks up on businesses. You might feel fine because you're making sales—but if those sales are tied up in receivables or inventory, you can be "profitable" and still run out of cash.
What "Healthy" Looks Like
| Ratio | What It Means |
|---|---|
| Below 1.0 | ⚠️ Warning — may struggle to meet short-term obligations |
| 1.0 - 1.2 | Tight — limited buffer for unexpected expenses |
| 1.2 - 2.0 | Healthy — good liquidity position |
| Above 2.5 | May have idle cash that could be invested in growth |
A ratio between 1.5–2.5 indicates strong liquidity without excess cash sitting idle.
What to Do
- Measure at the same time each month — The ratio fluctuates through billing cycles
- Separate "current" from "quick" — If most of your current assets are slow-moving inventory, your actual liquidity is worse than the ratio suggests
- Watch the trend — A ratio dropping from 2.0 to 1.3 over six months is more concerning than a stable 1.3
Ratio #3: Days Sales Outstanding (Are Customers Actually Paying?)
What It Is
Days Sales Outstanding (DSO) measures how long it takes, on average, to collect payment after you've invoiced a customer. It's a direct measure of how well your credit and collections processes are working.
Formula:
DSO = (Accounts Receivable / Total Credit Sales) × Number of Days
Why It's a Warning Sign
Here's the trap: you might be booking strong sales and feeling good about revenue—but if customers are taking 90 days to pay instead of 30, your cash flow is being squeezed. You're essentially providing interest-free loans to your customers while paying your own suppliers on time.
Even worse? 68% of companies receive over half of their payments after the due date. Late payment is endemic in Australian business, and if you're not tracking it, you're probably a victim.
What "Healthy" Looks Like
| DSO | Assessment |
|---|---|
| Under 30 days | Excellent — fast collections |
| 30-45 days | Good — healthy cash conversion |
| 45-60 days | Average — room for improvement |
| 60-90 days | Concerning — cash flow at risk |
| 90+ days | ⚠️ Critical — likely bad debts building |
The median DSO across industries is 56 days, but this varies significantly. Professional services often run 60-90 days; retail should be near zero (point of sale payment).
The key benchmark: If your DSO is 25% or more above your standard payment terms, you have a collections problem.
What to Do
- Run an aging report weekly — Know exactly what's in 0-30, 31-60, 61-90, and 90+ day buckets
- Follow up at 7 days overdue, not 30 — The longer you wait, the less likely you'll collect
- Consider invoice financing — If DSO is killing your cash flow, factor your receivables as a bridge while you fix the underlying problem
Ratio #4: Cash Conversion Cycle (How Long Is Your Money Trapped?)
What It Is
The Cash Conversion Cycle (CCC) measures how many days it takes to turn your investment in inventory and operations back into cash. It combines three flows: how long you hold inventory, how long customers take to pay you, and how long you take to pay suppliers.
Formula:
CCC = Days Inventory Outstanding + Days Sales Outstanding - Days Payable Outstanding
Or in plain English: How long stock sits on shelves + How long customers take to pay - How long you take to pay suppliers
Why It's a Warning Sign
A lengthening CCC is one of the clearest indicators of brewing cash flow trouble. For an SME to grow profitably, it must come to grips with the Cash Conversion Cycle.
Here's why it matters: every day your cash is tied up in inventory or receivables is a day you can't use it to pay bills, invest in growth, or handle emergencies. When the CCC stretches out, businesses often resort to expensive short-term borrowing—or simply run out of cash.
What "Healthy" Looks Like
| CCC | Assessment |
|---|---|
| Negative | Excellent — you're paid before you pay suppliers (common in e-commerce) |
| Under 30 days | Strong — efficient working capital management |
| 30-45 days | Target range for most industries |
| 45-60 days | Average — room for improvement |
| 60+ days | ⚠️ Concerning — working capital management needs attention |
Industry matters: FMCG companies typically run 10-20 day CCCs, while luxury goods manufacturers often exceed 90 days. Compare yourself to your industry, not to arbitrary benchmarks.
What to Do
- Attack all three components — Reducing CCC by 10 days might come from faster inventory turns, quicker collections, or negotiating longer supplier terms
- Forecast cash needs — If your CCC is 60 days and you're growing 20% per year, you'll need significant working capital just to fund that growth
- Consider the trade-offs — Stretching suppliers too far damages relationships; holding too little inventory risks stockouts
Ratio #5: Debt Service Coverage Ratio (Can You Handle Your Debt?)
What It Is
The Debt Service Coverage Ratio (DSCR) measures whether your business generates enough cash to comfortably service its debt obligations—principal, interest, and lease payments.
Formula:
DSCR = Net Operating Income / Total Debt Service
Why It's a Warning Sign
When a company's DSCR equals 1.0, it's generating just enough cash to cover its exact debt obligations—with nothing left for reinvestment, emergencies, or profit distribution. Below 1.0, and you're not generating enough to meet your obligations at all.
This ratio is critical because it's exactly what banks look at when deciding whether to extend credit—or call in existing loans. A declining DSCR often triggers covenant breaches, which can lead to loan acceleration at the worst possible time.
What "Healthy" Looks Like
| DSCR | Assessment |
|---|---|
| Below 1.0 | ⚠️ Critical — cannot meet debt obligations from operations |
| 1.0 - 1.15 | Tight — at risk if income dips |
| 1.15 - 1.25 | Minimum acceptable for most lenders |
| 1.25 - 2.0 | Healthy — comfortable buffer |
| Above 2.0 | Strong — preferred by most commercial lenders |
Most commercial banks require a DSCR of 1.15–1.35 to ensure sufficient cash flow for ongoing loan servicing. The SBA looks for at least 1.15, while many banks require 1.25 minimum.
What to Do
- Calculate with ALL debt — The most common mistake is not accounting for existing business debt when calculating DSCR
- Know your covenant requirements — Check your loan agreements for minimum DSCR requirements and monitor monthly
- Plan before you borrow — Calculate how new debt will affect your DSCR before taking on additional obligations
How These Ratios Work Together
No single ratio tells the whole story. The power is in seeing how they interact:
| Scenario | What's Happening | What to Check |
|---|---|---|
| Gross margin down, DSO up | Discounting to win business from slow-paying customers | Customer quality and pricing strategy |
| Current ratio down, CCC up | Cash trapped in operations | Inventory management and collections |
| DSCR down, all others stable | Taking on too much debt relative to income | Debt restructuring options |
| Everything declining together | Fundamental business model problem | Strategic review needed |
The warning pattern: When multiple ratios deteriorate simultaneously over 2-3 quarters, the business is heading for serious trouble—even if the P&L still shows profit.
What You Should Do Now
1. Calculate your baseline today
Why: You can't spot deterioration if you don't know your starting point. How: Run these five calculations using your last 3 months of financials.
2. Set up monthly tracking
Why: Annual reviews catch problems too late; monthly tracking lets you course-correct. How: Add these five ratios to your monthly financial review. The ATO's free financial health tool can help.
3. Know your industry benchmarks
Why: A 40-day DSO might be excellent in consulting but terrible in retail. How: Check ATO small business benchmarks for your industry.
4. Act on early warnings
Why: The businesses that survive downturns are those that respond early—cutting costs, improving collections, or restructuring debt before it becomes critical. How: If any ratio moves 15%+ in the wrong direction, investigate immediately.
5. Get a second opinion
Why: These ratios are diagnostic tools, not prescriptions. The right response depends on your specific situation. How: If you're seeing concerning trends, talk to an accountant who can help you interpret the numbers and plan a response.
The Bottom Line
Business failure rarely comes out of nowhere. The warning signs are there—in the numbers—months before the crisis hits. The difference between businesses that survive and those that don't often comes down to whether anyone was watching.
These five ratios won't prevent every problem. But they'll make sure you're not blindsided by one.
Start tracking them today. Your future self will thank you.
Sources & Further Reading
- ASIC Insolvency Statistics
- RBA Financial Stability Review: Company Insolvencies (April 2025)
- Business Queensland: Financial Ratios and Calculators
- Business.gov.au: Review Your Financial Health
- ATO Small Business Benchmarks
- Xero: How the Current Ratio Formula Works
- Moula: What's a Debt Service Coverage Ratio?
- Corporate Finance Institute: Debt Service Coverage Ratio
ThinkWiser helps Australian business owners make sense of their numbers—without the jargon. If you're seeing warning signs in your financials, or just want a second pair of eyes on your business health, we're here to help.
