Calculating and understanding financial ratios is a helpful, yet often underutilized, strategy for business owners. Business leaders that are trying to operate more efficiently or increase valuation may reap significant benefits from the proper calculation, understanding, application of liquidity, profitability, solvency, expense ratios, and other financial metrics.
1. Profitability ratios
Profitability ratios measure the income or operating success of an entity over a given period of time. For example, if a business has $1M in revenues, and $200,000 in net income, for a calendar year, then its net income ratio for that year is 20 percent. This information is useful when measured over time, as part of a trending analysis, or in comparison to others in the industry.
2. Liquidity ratios
Liquidity ratios measure a company’s short-term ability to meet its cash funding needs. For example, if a company has $1.5M of cash and accounts receivable, and $1M of accounts payable, then its current ratio is 1.5:1. This is an important tool for management or investors to use when making decisions about how to allocate resources.
3. Solvency ratios
Solvency ratios measure a company’s ability to meet its long-term obligations. For example, if a business has $5M in total liabilities, and $10M in total assets, then its debt-to-assets ratio is 50 percent. This information would be particularly helpful to a prospective buyer evaluating a business that may have long-term obligations, such as a mortgage payable.
4. Expense ratios
Expense ratios measure the impact particular expenses have on your business. For example, a service company could measure payroll, advertising, and/or travel expenses as a percentage of sales and measure how these change over time in an attempt to better allocate resources when running the business.
These are basic financial ratios, but there are many other financial metrics that may be used to evaluate short term and long- term business performance, and to assist with decision-making.
For assistance with financial ratios, or with any other legal needs related to your business, contact Fournier Legal Services at email@example.com or call 860.670.3535 now for a free consultation and planning session.