Why ratios are important

This is an important indication of financial health. To what degree does an enterprise utilize borrowed money and what is its level of risk? You may want to develop your own customized ratios to communicate results that are specific and important to your organization. Here are some examples. Skip to main content.

For ratios to be useful and meaningful, they must be: Calculated using reliable, accurate financial information does your financial information reflect your true cost picture? Calculated consistently from period to period Used in comparison to internal benchmarks and goals Used in comparison to other companies in your industry Viewed both at a single point in time and as an indication of broad trends and issues over time Carefully interpreted in the proper context, considering there are many other important factors and indicators involved in assessing performance.

Ratios can be divided into four major categories: Profitability Sustainability Operational Efficiency Liquidity Leverage Funding — Debt, Equity, Grants The ratios presented below represent some of the standard ratios used in business practice and are provided as guidelines. The Ratios Profitability Sustainability Ratios How well is our business performing over a specific period, will your social enterprise have the financial resources to continue serving its constituents tomorrow as well as today?

Ratio What does it tell you? If overall costs and inflation are increasing, then you should see a corresponding increase in sales. If not, then may need to adjust pricing policy to keep up with costs. The nature and risk of each revenue source should be analyzed. Is it recurring, is your market share growing, is there a long term relationship or contract, is there a risk that certain grants or contracts will not be renewed, is there adequate diversity of revenue sources?

Organizations can use this indicator to determine long and short-term trends in line with strategic funding goals for example, move towards self-sufficiency and decreasing reliance on external funding. For the purpose of this calculation, business revenue should exclude any non-operating revenues or contributions.

Total expenses should include all expenses operating and non-operating including social costs. A ratio of 1 means you do not depend on grant revenue or other funding. Is your gross profit margin improving? Small changes in gross margin can significantly affect profitability.

Is there enough gross profit to cover your indirect costs. Is there a positive gross margin on all products? Ratios measure companies' operational efficiency, liquidity, stability and profitability, giving investors more relevant information than raw financial data.

Investors and analysts can gain profitable advantages in the stock market by using the widely popular, and arguably indispensable, technique of ratio analysis. Financial ratios provide a standardized method with which to compare companies and industries.

Using ratios puts all companies on a relatively equal playing field in the eyes of analysts; companies are judged on their performance rather than their size, sales volume or market share. Comparing the raw financial data of two companies in the same industry offers only limited insight.

Ratios go beyond the numbers to reveal how good a company is at making a profit, funding the business, growing through sales rather than debt and a wide range of other factors.

Financial ratios are important tools for quantitative analysis. Certain ratios are available to evaluate both short- and long-term financial and operational performance, making them useful at identifying trends in the business and providing warning signs when it may be time to make a change.

There are also specific ratios that can measure important variables essential to one industry or another. By evaluating particular ratios, a business can benchmark itself against similar companies and understand its strengths, weaknesses, threats and areas of opportunity. While there are dozens of ratios to consider here are some common ones many companies include in their annual or quarterly assessment. David Cameron commissioned Julie Dean OBE the founder of The Cambridge Satchel Company to carry out an independent review of what additional support could be provided to the growing number of self-employed people.

National Insurance is charged on profits of a sole-trader or partnership. Why are ratios important? For business analysis, ratios are far more useful than just looking at the absolute numbers.