Common financial ratios and why they matter for your business

The key to running a successful small business lies in effective planning and financial management. Financial ratios are helpful in deciphering mass amounts of numbers that may seem meaningless and too abstract to interpret as they stand. Generating analyses of these numbers can establish trends over a period of time and show a comprehensive outlook of your business’ financial state.

The use of ratios is at the center of how businesses gain insight on how to move forward with short and long term considerations with their operations. Once a bundle of ratios is calculated, you can compare your business to others and see where you stand in relation. This assists owners in deciding where they want to line up compared to their competition in terms of resources used in certain areas of their business. Here are some commonly seen ratios used in business management:

Comparison Ratios

Often called balance sheet common size ratios, these make comparisons between assets and liabilities. These could include increasing or decreasing cash flow or accounts receivable balances. For example, with the data derived from a comparison ratio, a decision can be made to tighten up the bill collection policy you use.

Efficiency and Turnover Ratios

Turnover ratios give insight into how efficiently your business is utilizing its assets and managing its liabilities. These apply to businesses with a product they sell and that store inventory. A high efficiency and turnover ratio would indicate a need to change how much is stored at any one point in time as there is a risk of stock-outs.

Cash and Liquidity

Cash and liquidity shows if investments are able to be generated into the growth of the business or capital assets. A couple common ratios to assess cash and liquidity include the current and working capital. This assesses whether the business has liquidity to pay for short term expenses and debt. If that ratio is high, some cash can be spared to be used for investing in long term capital.

Business owners should strive to incorporate the analyses of various ratios into their business operations as often as possible, as it will lead to long term benefits and likely prevent financial losses to the company.