Financial Ratio Analysis is  one of the most invaluable activities that any business should do as part of their financial statement  analysis. Results from this exercise will help your business  make strategic business decisions that will help your business grow.

Profitability Ratios

These ratios show your business’s  ability to generate profit after expenses.  Some common ratios that measure this are as follows:

Gross Profit Margin

To arrive at your gross profit margin  you take your gross profit  (Sales less Cost of Goods Sold) divided by the Sales.

Return On Assets (ROA)

This ratio is computed based on your net income divided by your average total assets. It shows you how much earnings your business is creating on the resources (assets)  that your company invested in.

Return On Equity (ROE)

The ROE is similar to the ROA except that, you are comparing net income to the  shareholders or owners equity

Liquidity Ratios

These ratios are a measure of  your business’s ability  to pay off its short-term debts in the event that the business needs to liquidate its assets. To measure liquidity, you can look at the following ratios:

Current Ratio

The current ratio  divides your business’s  current assets by  the current liabilities. The higher the current ratio, the more likely that a business can pay off its short-term obligations.

Acid Test Ratio or Quick Ratio

The Acid Test ratio is similar to the current ratio but instead of using all the business assets it uses only the liquid or easy to convert to cash assets. The latter which include cash, short term investments and accounts receivables are often referred to as quick assets.

Inventory is excluded in this test because it generally takes longer to convert to cash compared to the other ‘quick assets’.

Turnover Ratios

These ratios show how quickly you can turn your assets into income, and the most common are the following:

Asset Turnover Ratio

To know if your business is effectively using your assets to make revenue you can use the asset turnover ratio. This is computed by dividing your sales with your average total assets

Inventory Turnover Ratio

This ratio is useful when you are selling inventory because you will want to know if your inventory is moving as it should. The ratio shows how often your goods are sold in a specified period. 

 If  the ratio is low, it could mean that your cash is tied up in your inventory. To compute  this ratio you take the  cost of goods sold for the year divided by the average inventory in the same period.

Leverage Ratios

The leverage ratios will show the ability of your business to pay off its debt. 

Debt To Equity Ratio

This ratio compares your total debt to your total equity. A company may be  funded by debt and investments from stockholders and comparing both with each other will show your total leverage.

Debt To Asset Ratio

The ratio shows the the percentage of total assets that is owed to creditors. To calculate it the total liabilities are  divided by the assets

Financial Ratios are an invaluable performance indicator for your business. If you would like a Financial Statement Analysis  Report please  contact us .