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Importance Of Financial Ratio

Analyzing your company’s financial ratio can provide you with valuable insights into profitability, liquidity, efficiency and more. The financial ratios can help you visualize how your company has performed over a given period of time. You can also compare your company’s financial ratios with industry averages to see how you compare to other businesses in your sector.

Financial ratios may also be used by investors to determine the health of a business. If your company is publicly traded, it’s a good idea to monitor key financial ratios, as these numbers can impact how investors view your company. By understanding the factors that affect these ratios, you can take steps to produce results that will be more attractive to investors.

Important financial ratios for companies

Cash flow ratios:

  • Current ratio: (current assets/current liabilities)

  • Quick ratio: (Current assets-inventory/current liabilities)

  • Account receivable days: Account receivable/Net sales x 365)

Leverage ratios:

  • Debt-to-equity: Total debt/ Total equity

  • Debt-to-asset: Total debt/Total assets

  • Interest coverage ratio: Operating income/Interest expenses

Profitability ratios:

  • Gross profit margin: Net sales-cost of goods sold/Net sales

  • Operating profit margin: Operating income/Net sales

  • Earnings before interest, taxes, depreciation, and amortization (EBITDA) margin: EBITDA/Net sales

Which financial ratio should you measure?

You should focus on areas of your business that are currently of the highest priority to your treasury department and executive suite. For example, if you are starting a new project that will require substantial funding, you may want to focus on reducing your existing debt-to-equity ratio before taking out additional commercial loan. If your organization is having trouble meeting its monthly expenses, cash flow ratios can help you uncover opportunities to strengthen cash flow and improve your accounts receivable processes.

Alternatively, if your company is in a good financial position and is primarily focused on finding ways to support growth and attract investors, then profitability ratios may be the most important types of ratios to monitor.

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