Financial Ratios are a great way to measure your company to ensure that it remains viable as well as is growing in the right direction.
There are four basic measures of a business:
- Liquidity: Liquidity measures your company’s ability to pay its immediate or short-term (under one year) obligations. If a business cannot pay its bills – it is destined to fail in the near term.
- Safety: Safety measures your company’s ability to withstand unfavorable market situations – like the current economic sluggishness or future market declines. The inability to withstand such market situation means your business is essentially standing on thin ice.
- Profitability: Profitability measures your company’s ability to cover its overhead (all the expenses not directly related to providing your product or service). This shows your company’s ability to cover marketing, selling and payroll expenses as well as taxes and interest payments.
- Operating Performance: Operating Performance measures your company’s current management of cash flow in and out of the business. The better cash flow is managed, the more profits the business can realize in the long-term. Moreover, the better cash flow is managed, the better the operations of the business – meaning it should not face credit crunches or financial surprises not to mention to ensure that cash in the business is being used in the most efficient manner (another way to increase profits).
Note: While financial ratios are a great measure of your business – they are, for the most part, a snapshot of your business as it stands. These ratios can show areas within a business that need improvement. But, following these ratios over time (called trend analysis) will provide more useful information to the business owner as these ratios may look good today but could be trending downward – showing a slow but steady decline in the business.
If you want to better understand the operating soundness of your business – just click a link above to calculate those financial ratios. Not sure if you understand these ratios or what they mean – we try to provide explanation were needed!
What you will need:
Copy of your most recent financial statements:
- Income Statement
- Balance Sheet
- Cash Flow Statement
Keep in mind, that it is better to measure your company over time to determine if your business is growing (getting better), stagnate (staying the same and not moving forward) or declining (self-explanatory).
Thus, get a copy of your past and current financial statements (monthly, quarterly or annually) and compare your financial ratios over time.
Again, to measure the strength of your business – calculate the following Financial Ratios:
Disclaimer: Business Money Today does not retain or track you or the data you input. These ratios are for education purposes only and are in no way an adequate substitute for a professional financial advisor.