Using ratios in your business
A ratio is a means of relating one number to another. In financial analysis, ratios may be expressed as the ratio, rate or percentage, depending on your own preference.
To provide useful meaning, financial ratios need to be compared with, for example:
- the trend of your results over the past year or so (i.e. trend analysis)
- the results by other competitors (if these are available)
- industry benchmarks or general business standards
- budgeted results
- the effect of economic conditions.
Commonly used financial ratios
Your first decision will be which financial ratios to use. The most common categories of ratios are:
- profitability - use gross profit margin and net profit margin ratios as 2 key indicators of business performance and likelihood of success
- cash flow and liquidity - use these ratios to assess the amount of working capital you have in your business, and work out how solvent the business is in the short to medium term
- risk and return - use these ratios to judge how successful investment in your business is, and what effect further investment may have in specific parts of the business
- stock turnover and sales - use these ratios to identify overstocking or deficiencies in your production or marketing strategies.
Non-financial ratios can also be important to your business, as they can highlight issues that may not show up on the balance sheet. Staff turnover and client satisfaction are examples of non-financial factors you may want to examine.
Learn more about non-financial ratios.
Getting help with financial ratios
Financial advisers can recommend the most suitable ratios for your business and show you how to produce reports to calculate and monitor them.
When you have started to analyse the figures produced by your financial ratios, you can use them to benchmark your business. This will help you assess productivity by comparing your performance to other businesses in your industry.
Business and industry associations often collect financial data and make it available online.