Why are financial ratios useful?
Financial ratio analysis is one of the simplest techniques a business owner/manager can use to look at their company’s performance.
It allows a business owner and their advisers to look at the performance of the company across a number of time periods as well as benchmarking performance against other firms in your particular industry. Ratio analysis positions a business with regard to profitability, liquidity, asset utilisation, gearing and market value. It facilitates better decision making and validates the effectiveness of management interventions.
How do I rate my company’s performance?
Financial ratios are an excellent way of analysing a company’s financial position however they mean little in isolation. Comparative data gives a basis for comparison and can help determine if the ratio is appropriate for your business. If your financial ratios are very different to those in your industry, you may want to examine why and perhaps take corrective action. Trend Analysis is also useful. Past year’s balance sheet data or monthly accounts allows you to calculate the financial ratios for several years, or quarters or months in order to track trends in your ratios.
See a sample of industry ratios.
Limitations of Financial Ratio Analysis
Even though financial ratio analysis is one of the most popular methods of financial analysis, it does have its limitations. Ratio analysis for a company should be benchmarked to ratios in the industry and window dressing should not be used. If in doubt, consult your accountant.