What are Financial Ratios? Can they be used to run a small business or are they only for big companies and stock traders?
In the 2016 Week 50 episode of Up and to the Right we'll learn the Secret Life of Ratios and how they can be used to operate and improve your small business.
The tool this week is a ratio analysis calculator. All you have to do is download it from beyond50percent.com/2016w50 and enter 12 values from your own financial statements. Ratio analysis just got easy!
In the Reading Room this week I'm recommending The Dip by Seth Godin. Push through the tough times and know when to quit when you're going in a direction that doesn't lead where you want to go.
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Resources
Show Notes
What are Financial Ratios?
Financial Ratios are just the comparison of two numbers from our financial statements. This allows us to understand the relationship between those numbers and gain valuable insight about business performance.
We also use Financial Ratios to compare businesses to either each other or to industry standards. This is possible because the calculation of a ratio removes the dollar value from the figure and these simplified numerical values can be easily compared without the distraction of thousands vs. tens or hundreds of thousands (or millions... you get the idea).
If all of this is starting to sound a little bit like math - have no fear! The spreadsheet in the tools section will automatically calculate 7 helpful ratios that all business owners should be aware of.
All you have to do:
- Download the Excel spreadsheet above.
- Enter 12 values from your financial statements each month.
- Determine the benchmarks that are appropriate for your industry and enter them for comparison.
How do Financial Ratios apply to Small Business?
The ratios we look at can provide both performance benchmarks and warning signs to be careful of. Small business owners need to understand and follow the ratios for their business because often small business's have fewer resources to recover if/when a problem occurs and anything we can use to correct our course as early as possible is a benefit.
Which Financial Ratios should I be looking at?
- Current Ratio
- Quick Ratio
- Gross Margin %
- Operating Margin %
- Inventory Turnover
- Average Days to Collect (Days Sales Outstanding - DSO)
- Cash Flow to Debt Ratio
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