Pastel Overview of Financial Ratios
Ratios are derived by comparing one value against another in order to assess whether the ratio indicates a strength or weakness of the company. This way ratio analysis helps you to make meaningful conclusions from values drawn from financial statements and other reports about the state of the company activities.
There are many ratios but they generally fall into the following areas. There are ratios that measure:
Profitability of the company.
Solvency and liquidity
Stability and ability of the company to meet its obligations.
Efficiency of business activities.
Shareholder’s earnings from their investment.
However, we need to emphasise the point that ratio analysis on its own is not enough in assessing the strength or weakness of a company. Other factors need to be taken into account when making a final judgement of the state of your company’s activities. To make a meaningful ratio analysis, you should:
- Compare them over a reasonable time period.
- Compare against those of similar companies.
- Consider intervening factors between periods and / or similar companies.
For example, one period’s ratio may differ considerably to another period’s ratio because of extraordinary or contingent events that occurred on one period but not in the other.
In terms of similar companies, you can consider their historical background. For example, an older company is likely to be more established and therefore obtain standard ratio values than a new company and so forth.
Finally, you need to allocate detailed financial categories to each general ledger account before you can produce ratios. In other words, you cannot have an account that has either the Unallocated Balance Sheet or Unallocated Income Statement category. You assign financial categories in the Edit…General Ledger…Accounts menu option