Accounting Primer: Financial Statement Ratio Analysis

Ratio Analysis expresses the relationship between two selected accounting elements and is one technique used in conducting a financial analysis. When comparing your business’s ratios to those in for your industry standards, ask:

  1. Is there a difference between my company’s ratio and the industry average?
  2. Is it a significant difference?
  3. Is the difference good or bad?
  4. What are the possible reasons for the difference? 
  5. What is the most likely reason?
  6. Is there a trend that seems to be occurring?
  7. Does this trend require that I take some action?
  8. If so, what actions should I take to correct the problem?

Remember, ratios are indicators of your financial condition. It is common for ratios to fluctuate from month to month. The best way to read ratios is against industry norms and against past ratios as a trend. When considered against industry norms and as trend analysis you can get a very good sense of your business’s performance.

The 12 key ratios (grouped) are:

Liquidity ratios – indicate whether the business will be able to meet its short-term financial obligations as they come due.

  1. Current Ratio
  2. Quick Ratio

Leverage ratios – measure the relationships between financing supplied by a firm’s owners and by its creditors.

  1. Debt Ratio
  2. Debt-to-Equity Ratio
  3. Times Interest Earned (TIE) Ratio

Operating Ratios – help an entrepreneur evaluate a company’s overall performance and indicate how effectively the business employs its resources.

  1. Average Inventory-Turnover Ratio
  2. Average Collection Period Ratio
  3. Net Sales to Total Assets Ratio: AKA The Asset Turnover Ratio

Profitability Ratios – indicate how efficiently a small company is being managed and provide information about a company’s ability to use its resources to improve its bottom line.

  1. Net Profit on Sales Ratio: AKA the Net Profit Percentage
  2. Net-Profit-to-Assets Ratio: AKA the Return on Assets Ratio
  3. Net Profit to Equity Ratio: AKA the Return on Investment Ratio