There are quite a few ways you can note and record your business performance using available data. Using financial ratios, you are easily able to assess all of the areas where your business performance is excelling or underachieving. This way, you are able to judge where you need to improve in the areas you lack and where you need to retain and maintain the areas you have had success.
The other motive of using financial ratios in your business is that you are able to see and decide just how beneficial or disadvantageous it will be in one area if any such modifications are made. You can easily measure the effects that the changes will have elsewhere in another area.
The importance of monitoring figures closely in your business will help you to minimize waste and maximize efficiency which will, in return, grow and flourish your business in time.
Where do you get your information to calculate your financial ratios? Bookkeeping will help you in providing all of the necessary and relevant information from which all of your accounts are formulated. The process of bookkeeping is a recognized and well-defined process in the field of business and accounting.
Each and every transaction, whatever the nature (purchase or sale) may be, has to be recorded. The process of bookkeeping helps ensure accurate and timely records.
4 Ways to Assess Your Business Performance Using Financial Ratios
The most regular and familiar ratio used is called the current ratio. This ratio calculates the ratio of current assets to the ratio of current liabilities. The current ratio is used to help specify a company’s potential and capacity to pay off their short-term invoices and bills.
If the business has more liabilities compared to their assets, the current ratio will be less than one. If the business has more assets compared to their liabilities, the current ratio calculated will be more than one.
If a business’s current ratio is high, it indicates they have a safety cushion. If the business has more assets than liabilities, their flexibility will be increased. If the business has more liabilities compared to their assets, they might have to convert their receivable balances and some inventory items into cash, which may not be easily done.
In order to improve their current ratio, business can pay off their debts, collect their due receivables, purchase inventory only when required, and convert their short-term debts into long-term debts.
Liquidity ratios can be found of three types:1. Current ratio: Calculated when the sum of all of the company’s current assets are divided by their total current liabilities. This ratio measures if you have sufficient assets to pay for your liabilities. If your current ratio is calculated to be two, it means that you have twice as much current assets as your current liabilities.
2. Quick or acid-test ratio: This ratio is calculated by dividing current assets (not including stock) by the total current liabilities. If your quick or acid-test ratio shows the result of one, it means your business’s liquidity levels are sufficiently high. This is an indication of your business having solid financial health.
3. Defensive interval: This ratio is calculated by dividing the total liquid assets by daily operating expenses. The ratio will give an estimated idea of how long you can survive your business without any cash flowing in. Normally, it is found to be somewhere between 30 to 90 days.
Solvency ratios measure the financial stability of a business since it calculates a business’s debt in respect to its equity and assets. Any business found to have too much in debt might not have enough flexibility to manage their cash flows if the interest rates are found to rise or if the business conditions start to deteriorate.
The common solvency ratios calculated are debt-to-asset and debt-to-equity. The debt-to-asset ratio is found by dividing total debt by the total assets. The debt-to-equity ratio is calculated by dividing total debt by total shareholders’ equity. Shareholders’ equity is found by calculating the difference of all total assets and all total liabilities.
Profitability ratios calculate the management’s ability to change the amount of sales dollars earned to cash flow and profits. The net profit ratio can be used to evaluate your business’s profitability. Divide the total profit before tax by the amount of net sales to find out your net profit.
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