Financial Assessments: 4 Financial Ratios Business Owners Need to Understand

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Man sitting at desk, under sunlight from window.The financial health of your business is integral for accessing new funding, planning new initiatives and driving stable growth. Financial assessments help business owners understand what’s standing in the way of next-level growth by quantifying GAPS in current practices and future goals. This type of deep-dive begins with an exploration of the financial ratios that are most relevant to your operations.

Financial ratios are commonly used by lenders and investors to measure stability, but they’re also a powerful tool for business owners. Each of the four main types of financial ratios measures financial wellbeing from different perspectives.

 

Liquidity Ratios

Liquidity ratios look at your company’s cash flow positioning. By assessing the relationship between current liabilities (not long-term debt) and liquid assets, this metric provides important insight into what would happen in the event of an emergency or unexpected change – an essential concern that’s explored when conducting financial assessments.

 

The Current Ratio measures current assets (cash, accounts receivable, inventories, etc.) in relation to short-term liabilities (those that will be paid in the next year).

 

The Quick Ratio looks at your ability to meet obligations with your most liquid assets. Therefore, inventories are subtracted from the current assets prior to dividing the number by the short-term liabilities.

 

Efficiency Ratios

Efficiency ratios analyze your company’s ability to use its assets to generate income and manage liabilities effectively. When combined with in-depth financial assessments, it’s a powerful way to quantify the efficiency of your operations.

The Inventory Turnover Ratio assesses how long it takes for inventory to be sold and replaced over time. It provides great insights into where you can optimize buying practices or inventory management.

 

The Average Collection Period Ratio quantifies the average length of time it takes customers to pay for the services or products they purchase. It can provide valuable data that enables you to assess policies or implement collection procedures.

 

Profitability Ratios

Profitability ratios evaluate your financial viability by assessing your ability to generate income in relation to the associated costs of doing business, including shareholders’ equity. It’s a highly effective measure that’s often used when financial assessments are comparing your operational efficiency against those of your competitors or industry standards.

 

A Net Profit Margin measures your after-tax profits relative to your sales.

 

An Operating Profit Margin (aka coverage ratio) measures that earnings-to-sales relationship before taxes and interest.

 

The Return on Assets Ratio examines how well various assets and resources are being utilized.

 

The Return on Equity Ratio looks at the relationship between business profitability and shareholder investments – providing investors with insight into the percentage of earnings in relation to each invested dollar.

 

Leverage Ratios

Leverage ratios help investors and business owners determine whether your level of debt is sustainable. Debt can be a sign of an expanding and thriving business, or it can be a sign of trouble. Knowing the difference is key.

 

The Debt-to-Assets Ratio measures the portion of your assets that are financed by debt.

 

The Debt-to-Equity Ratio takes the Debt-to-Asset Ratio a step further by assessing it in relation to the value of shareholders’ equity.

 

The ideal ratio metric depends on the type of business you conduct and the purpose of the analysis. With any of these metrics, a “healthy ratio” will vary greatly by industry. Therefore, you should leverage specialized guidance before launching into financial analyses and financial assessments. At FocalPoint Canada, we use specialized financial assessments to power fact-based decision making.

 

Financial Assessments with FocalPoint Canada

At FocalPoint Canada, we guide our clients in overcoming challenges and leveraging opportunities with proven processes and methodologies that have been used by thousands of successful businesses over the past two decades. Our FocalPoint Business Coaches use their expertise to teach our time-tested methods through individual coaching, group sessions, or trainings and workshops.

 

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