Business Ratios

To assess a business, financial statements alone will not suffice. A true picture emerges only when numbers on the balance sheet and P&L are compared to other figures. Ratios are the most commonly used comparison tool.

Ratios are established from key figures on the financial statements. Ratios are simple to calculate. Sometimes a ratio is expressed simply as X:Y. Other times, one number is divided by another and the ratio is expressed as a percentage.

Ratios help assess the performance of a business. And help determine how a business compares to others in the same industry. Banks use business ratios to in determining whether credit can be extended to a business.

There are dozens of ratios that can be examined. The key is to choose which ratios are most applicable when examining a particular business type. Three commonly used ratio groupings are:

1. Liquidity ratios show the ability of a business to generate cash needed to pay bills. Liquidity ratios are sometimes called working capital ratios.
2. Efficiency ratios measure how effectively a business is using its assets and points to ways a business can improve operations.
3. Profitability ratios are the most important indicator of business performance. Profitability ratios demonstrate the performance and growth potential of a business.