Monday, July 21, 2008

Financial Ratios-Standards For Success

To qualify for the 113th Boston Marathon, Boston Athletic Association athletes must meet the designated time standard which corresponds to their age group. Every runner knows what that is for their corresponding age group and they constantly monitor their performance and trainings to that standard.

In business, performance standards are usually measured in terms of financial ratios. Financial ratio's and other key indicators are important. Think of these like the meters and lights on the dashboard of an automobile. Financial ratios are useful indicators of a firm's performance and financial situation. Most ratios can be calculated from information provided by the financial statements. Financial ratios can be used to analyze trends and to compare the company's financials to those of other company's.

Any successful business owner is constantly evaluating the performance of his or her company, comparing it with the company's historical figures, with its industry competitors, and even with successful businesses from other industries. To complete a thorough examination of your company's effectiveness, however, you need to look at more than just easily attainable numbers like sales, profits, and total assets. You must be able to read between the lines of your financial statements and make the seemingly inconsequential numbers accessible and comprehensible.

This massive data overload could seem staggering. Luckily, there are many well-tested ratios out there that make the task a bit less daunting. Comparative ratio analysis helps you identify and quantify your company's strengths and weaknesses, evaluate its financial position, and understand the risks you may be taking.

As with any other form of analysis, comparative ratio techniques aren't definitive and their results shouldn't be viewed as gospel. Many off-the-balance-sheet factors can play a role in the success or failure of a company. But, when used in concert with various other business evaluation processes, comparative ratios are invaluable.

A good place to start in understanding financial ratios is to go read the article on Financial Ratio in Wikipedia at Financial ratio - Wikipedia, the free encyclopedia

Next, you should determine which one’s you want calculate and monitor for your business. Some of the ratios to include and monitor are the current ratio, receivable turnover, receivable aging, average collection period, inventory turnover, debt ratio, debt-to-equity ratio, interest coverage, gross profit margin, return on assets and return on equity. These should be calculated periodically and compared to industry standards and previous periods. When comparing your company with industry figures, make sure that the financial data for each company reflect comparable price levels, and that it was developed using comparable accounting methods, classification procedures, and valuation bases.

Such comparisons should be limited to companies engaged in similar business activities. When the financial policies of two companies differ, these differences should be recognized in the evaluation of comparative reports. For example, one company leases its properties while the other purchases such items; one company finances its operations using long-term borrowing while the other relies primarily on funds supplied by stockholders and by earnings. Financial statements for two companies under these circumstances are not wholly comparable.

The following are some good websites to use to calculate the financial ratios you choose:

Financial Ratios

UW Libraries - Foster Business Library - Financial Ratios Calculator

If you have a business, decide today which financial ratios you will monitor. If you are just starting a business, put those financial ratios in your business plan. Success and decision are partners.

This is all for now. If you have any questions, you can always contact me at marty@martymcevoy.com. In addition, I would love your feedback to this post.

Take care,

Marty

No comments: