Financial Ratios are Key to Understanding Business Performance

Financial Ratios are Key to Understanding Business Performance

Let’s talk about financial ratios, (and no, this isn’t a dreaded math lesson where you crawl into a corner and hide). The key here is data—data that will help you run your business more effectively, guiding your planning and measuring what is working. The use of data takes effort, but it is worth it as Arthur C. Nielsen, market researcher and founder of the AC Nielsen company said, “The price of light is less than the cost of darkness.” And Peter Drucker, the late business management expert said, “What gets measured gets managed.”

 

Why are Financial Ratios Important?

 

Financial ratios are simply relationships of numbers taken from a company’s financial information in order to make useful comparisons. Financial ratios provide:

 

Business Insights

 

An analysis of financial ratios can provide important information on a company’s performance for management as well as for outside investors, vendors and financial institutions, including such areas as liquidity, profitability, debt and asset management.

 

Trend Analysis

 

Looking at financial ratios over periods of time helps analyze and manage trends in the company’s performance.

 

Competitive Comparisons

 

Companies use ratios to compare their performance versus competing firms. That may highlight strengths, weaknesses and competitive advantages, all contributing to better strategic planning.

 

Use These Financial Ratios to Understand Your Business Performance:

 

Profitability Ratios

 

A business owner will use these ratios to understand the profitability of a business and to talk with lenders in order to make good business decisions:

 

Gross Margin- This ratio is used to help make pricing decisions.

 

Net Profit Margin – This shows the percentage of earnings that turn into profit and the percentage which is left to go back into business operations.

 

Return on Investment – This calculation helps determine what investments are worth to the business.

 

Financial Leverage Ratios

 

A business owner will use these financial ratios to examine how much business capital comes from debt and to assess how well the company uses and manages its debt:

 

Debt to Asset Ratio – This ratio measures the percentage of assets financed with borrowed money.

 

Debt to Equity Ratio – This examines how much debt a business has in comparison with the capital that is available.

 

Interest Coverage Ratio – This ratio shows how well the business can pay interest expenses on its debts.

 

Working Capital – This shows the liquidity of a company to pay short-term obligations.

Stock buying and evaluation ratios used to manage the financial ownership of a company are:

  • Earnings per share
  • Price-earnings ratio
  • Return on equity

Get Expert Financial Assistance—Don’t Fly Blindly with Numbers

Contact Doerhoff & Associates CPA, based in Jefferson City, MO for professional accounting and financial assistance that will help you achieve the business success you are striving for. Doerhoff & Associates has one goal in mind, to provide comprehensive business accounting services—designed specifically with you in mind.