For most people, financial ratios are not a major priority or concern for the day to day operations of running a business. That does not excuse the fact that it should be. Financial ratio analysis is crucial for identifying trends, understanding the financial statements, and even receiving better rates from lenders. The problem with financial ratio analysis is that it can be extremely complex, and if you do not make the direct connection to your company, it can be completely worthless. Here are 3 ways to start your financial analysis journey:
- Improve Lending Rates: An often overlooked opportunity to improve your company’s profitability is to receive better rates from lenders. Lenders decide rates based partly on financial ratios. By understanding the financial ratios that lenders are basing their decisions on, and improving those ratios, your company will instantly become more profitable. The best part is there is an opportunity for financial ratios to improve without any additional capital or investments.
- Pick Two: To improve financial ratio analysis, start by keeping it simple. Focus on what is truly important to your company. A common mistake I have come across is companies having a dashboard of 20 financial ratios, but not focusing on the few that have a major impact. Not all financial ratios are treated equally and they should not be given the same amount of consideration.
- Cash is King: With that in mind, focus on the cash ratio, or more commonly known as the current ratio. The current ratio is calculated as current assets divided by current liabilities, which are both prominently displayed on your balance sheet. The current ratio shows the company’s ability to pay back short term obligations. A higher ratio indicates a higher capability of paying back its debts. The current ratio is extremely simple to calculate and should definitely be considered when a company is negotiating rate terms with lenders.
Which of these methods have worked best for your company? Are there any you would add to your “must have” list? Let us know on one of our social media channels below.