A financial ratio is a calculation of numerical values reported on the financial statements of the business. Calculating ratios gives a good picture of the financial position and performance of your business. However, you cannot rely on ratios alone. They are a starting point and further analysis determines your results with greater explanation.
Ratios are expressed as percentages, fractions and proportions, grouped into categories of financial position or performance with the most common being:
- Profitability ratios - show gross profit, net profit and return on equity for the business owner.
- Efficiency or Activity ratios - measure the efficiency of turnover and settlement of money owing to business.
- Liquidity ratios - identify whether the business has sufficient resources to meet its financial obligations.
- Gearing ratios - reflect the degree of risk associated with your business based on the loans the business may have.
The combination of ratios provides the business owner with a snapshot of the current health and viability of the business.
To gain further insight, business owners can apply these ratios to benchmarks. Benchmarking is used to compare similar business within an industry. These benchmarks help the business owner to identify where their performance can be improved. Take a look at the related links below to understand how benchmarking can be used for small business.
Watch this video on the importance of financial ratios analysis and discuss how you might benchmark your business idea to ensure it is positioned correctly.
Have a look at websites in your country that contain industry benchmarks. Share the website link with fellow learners (stating which country the link refers to).
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