In-Depth Articles
Financial Ratios Allow Insight for Business Owners
In recent economic times it is difficult to find time to deal with the many challenges faced by business owners. It is difficult to find enough time and cash to run your business, manage your employees effectively, and keep and attract customers. Financial ratios can help you gain insight into the strength of your company. They offer a quick shortcut on what your financial statements are saying. Financial ratios help business owners gain insight as to where your business has been, where it is, and where it is going.
Virtually any financial statistics can be compared using a ratio. In reality, however, small business owners and managers only need to be concerned with a small set of ratios in order to identify where improvements are needed. “As you run your business you juggle dozens of different variables,” David H. Bangs, Jr. wrote in his book Managing by the Numbers. “Ratio analysis is designed to help you identify those variables which are out of balance.” The following are a few selected ratios that can help you gain insight into your business.
Profitability ratios show your company’s ability to generate profits and provide information about management’s performance in using the resources of the small business:
- Gross profit margin percentage: Gross profits/revenue-measures the margin of sales the company is achieving. It can be an indication of efficiency or marketing effectiveness.
- Net profit margin percentage: net profit/revenue-measures the overall profitability of the company, or how much is being brought to the bottom line.
Leverage ratios will show you how much debt your company is using:
- The debt to equity ratio: Debt/owners’ equity-indicates the relative mix of the company’s investor-supplied capital.
Liquidity ratios are very important to small business owners and are a good indicator of your company’s ability to pay its bills:
- Current ratio: current assets/current liabilities-measures the ability of an entity to pay its near-term obligations.
- The quick ratio: Quick Assets/current liabilities-provide a stricter definition of the company's ability to make payments on current obligations.
A ratio by itself has little significance. However, you can use ratios in a meaningful way by geographically comparing them to historical ratios, benchmarking to competitors, or industry averages. At Hughes, Snell & Co., P.A, we can perform such analyses and prepare reports of this information in a way that makes sense to the business owner. If you are interested, please contact our office and allow us to be your trusted advisor.
To ensure compliance with requirements imposed by the IRS, we inform you that any tax advice contained in this communication is not intended or written to be used, and cannot be used for the purpose of avoiding penalties assessed under the Internal Revenue Code.
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