If you are that type of business owner that prepares financial statements or reports and simply puts it away without deeply analyzing what the numbers are saying, you could be ignoring important vital health signs that your business is struggling and is in dire need of attention.
A ratio is simply the mathematical relationship of one number with another number. Applying that concept to accounting, the accounting ratios are simply the relationship of one number on your financial statements compared to another number in a different part of your financial statements. These numbers are analyzed by stakeholders to gain an insight into how profitable and solvent your business is. Ratios can also give an indication of the approximate market value of your business. If you are applying for any type of lending, banks will perform ratio analysis to determine if they should lend money to your business.
Ratios reveal information about different aspects of a business’s health. The five areas of analysis are liquidity, leverage/gearing, performance, market value and efficiency. Financial ratios are an important tool for tracking the performance of a business. It also facilitates the comparison of a business entity’s performance to other players within the same industry thus indicating if a business is operating within the ballpark average standard.
The insights that a business owner can gain from conducting their own ratio analysis are like a pivotal beacon that can guide and shape the direction of how your “business ship” sails. If the business owner can master the art of using ratios, they could potentially save more money in their pocket.
In the upcoming series of articles, we will explore the five different categories of ratios and learn more about the benefits and limitations of using financial ratios.
Stay tuned !
