One of the key components in developing the narrative of the business story is in analyzing the financial statements to gauge the past performance of the business. As such, understanding and calculation financial ratios is an important exercise.
Ratio analysis is an excellent tool for determining the overall financial condition of your business. Think of it as a way of “taking the temperature” of your company. It puts the information from your financial statements into perspective, helping to spot whether your business is at risk of insolvency or whether other negative financial patterns threaten the
health of your firm.
Ratios are also very useful for making quick comparisons between your business and other businesses in your industry. Banks and investors use them to help decide whether a business is a good credit or investment risk. Managers look at ratios to monitor operations and determine whether or not the company is running efficiently. For example, ratios can indicate whether a business is carrying a dangerous amount of debt, holding too much inventory, or not collecting accounts receivable quickly enough.
So let’s take a look at some of the ratios from the Statement of Financial Position.
Return on Sales Ratio (%)
Formula: Return On Sales (%) = (Net Profit before Interest ÷ Sales) × 100
This is the difference between what a business takes in and what it spends in the process of doing business. When you compare profit to sales volume, you can determine whether you’re making enough of a profit.
Return on Equity Ratio
Formula: Return on Equity = Net Profit ÷ Net Assets
It is used as a general indication of the company’s efficiency; in other words, how much profit it is able to generate given the resources provided by its shareholders.
More to come……
- How Do Ratios Impact the Financial Health of a Business? (thinkup.waldenu.edu)
- The Use of Financial Accounting Information in Making Informed & Ethical Business Decisions (thinkup.waldenu.edu)