Since Euclid’s rigorous analysis of the properties of ratios in 300 BC, financial ratio analysis has been a fashionable sport among creditors, investors and financial managers. However, very few owners and managers of small businesses rely on this very useful analytical tool as a beacon to help them to stay clear of bad weather. The top two reasons I often hear for not incorporating this tool into the daily management of the organization are: (1) I have no time, and (2) I have no idea how.
(1) I have no time – You have to make time. In fact, it does not take that much time. Values used in calculating financial ratios are taken from the corporation’s balance sheet and income statement generated every month. (What many organizations lack is timely financial statements but that is a topic we will address in a future blog). Once you have the statements, you have the ratios.
(2) I have no idea how – Well, read on.
Financial ratios are at the core of financial statement analysis. They turn monochromatic financial statements into colorful shapes with meaning and relevance. And they are easy to use, easy to understand and very useful in predicting potential cash flow crisis. Remember: Cash flow crisis don’t just happen!
The most popular ratios include Liquidity Ratios, measuring the organization’s availability of cash to pay its debts; Profitability Ratios, measuring the effectiveness of the company’s use of resources, control of expenses and financial return on its capital invested. The number of ratios is as varied as published financial authors. A simple Google search results in hundreds of lists of favorite financial ratios. If you are interested, we will be happy to send you our list of favorite financial ratios, just email us your request in the contact form above
During your budget process you should also earmark the target ratios for the upcoming year and review the target vs. actual ratios every month. Financial ratios are also very valuable tools when benchmarking your organization’s performance against competitors specifically or your industry more generally. These analyses will help you better understand how you are doing (vs. how you thought you should be doing) and how you are doing as compared to your peers.
Questions?
Please call us or email us for a free consultation at. (972) 332-1905 or email us at david@nosnik.com
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