Benefits of Ratio Analysis

Now that we understand what financial ratio analysis is all about, we are ready to evaluate the advantages and disadvantages of using it.

1] Track performance of business

Financial ratio analysis is a great tool to use for tracking the performance of your business. Think of the ratios as a gauge or tachometer of your business dashboard. Regular monitoring of your numbers will ensure that you can respond quickly to opportunities or challenges and it will help you to maintain the health of your business.

2] Comparison to Competitors

Ratio analysis allows a business to compare their performance to other entities that are operating within the same industry. This enables business owners to evaluate whether their business is operating on par with their peers and figure out if a change in financial strategy is required to pivot or not.

3] Plan for Financing

If you are planning to borrow money for your business or take on new investors, rest assured that banks and lenders will scrutinize and analyze the living daylights out of your financial statements to ensure that you are a safe borrower. Understanding what lenders are concerned with, you can use ratio analysis to mold your business into a strong, credible entity that is worthy of receiving financial help.

Financial ratio analysis can help identify if your business is over-leveraged or under-leveraged and is able to take advantage of growth expansion projects.

4] Identify Opportunities and Inefficiencies

Monitoring the efficiency and return ratios help business owners to identify areas where the business is underperforming. Using this knowledge, they are in a position to take action to streamline processes and save money that is being wasted or convert those inefficiencies into mega money-making opportunities.

5] Budgeting and Forecasting

Your financial statements provide a great starting point for preparing the budget for the upcoming year. Throw in some ratio analysis plus some Excel spreadsheet financial modelling, and you have a recipe to cultivate a robust budget and forecast that will push your business to achieve ambitious results that you as the business owner would never have dreamed of. With Excel, you can use financial ratios to evaluate scenarios of introducing a new product line or discontinuing a service line and much more.

6] Making Business Decisions

All business have a limited quantity of resources. Those resources have to be used as efficiently as possible for the highest gain. Ratio analysis helps businesses to identify where to allocate their scarce resources, identify trends and calculate a reasonable profit to remain operating in business.

7] Determine the Market Value When Selling Your Business

When you are ready to call it quits, you can prepare a lot of the homework for the sale of your business ahead of time. One important tool will be the ratio analysis. Regular monitoring of your company’s dashboard and good maintenance of your business operations throughout its lifespan will help you make sure that your business is a smooth-running engine at the time of sale. Knowing how to calculate the market value of your company shares will put you in a position to negotiate the best price for your company’s shares.