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Financial statement ratios support informed judgement and decision making most effectively when

Balance Sheets ; Cash Flow Statements ; Income Statements ; Return on Assets Financial ratios are relationships determined from a company's financial information and used for comparison purposes. Examples include such often referred to measures as return on investment ROIreturn on assets ROAand debt-to-equity, to name just three.

These ratios are the result of dividing one account balance or financial measurement with another. Financial ratios can provide small business owners and managers with a valuable tool with which to measure their progress against predetermined internal goals, a certain competitor, or the overall industry.

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In addition, tracking various ratios over time is a powerful means of identifying trends in their early stages. Ratios are also used by bankers, investors, and business analysts to assess a company's financial status. Ratios are calculated by dividing one number by another, total sales divided by number of employees, for example.

  • However, this ratio can be distorted by depreciation or any unusual expenses;
  • All small businesses require a certain degree of liquidity in order to pay their bills on time, though start-up and very young companies are often not very liquid.

Ratios enable business owners to examine the relationships between items and measure that relationship. They are simple to calculate, easy to use, and provide business owners with insight into what is happening within their business, insights that are not always apparent upon review of the financial statements alone. Ratios are aids to judgment and cannot take the place of experience. But experience with reading ratios and tracking them over time will make any manager a better manager.

PROFITABILITY OR RETURN ON INVESTMENT RATIOS

Ratios can help to pinpoint areas that need attention before the looming problem within the area is easily visible. Virtually any financial statistics can be compared using a ratio. In reality, however, small business owners and managers only need to be concerned with a small set of ratios in order to identify where improvements are needed. It is important to keep in mind that financial ratios are time sensitive; they can only present a picture of the business at the time that the underlying figures were prepared.

  • Yet another reason small business owners need to understand financial ratios is that they provide one of the main measures of a company's success from the perspective of bankers, investors, and business analysts;
  • Financial statement ratios support informed judgments and decision making most effectively 8, at midnight each question is worth points 1.

For example, a retailer calculating ratios before and after the Christmas season would get very different results. In addition, ratios can be misleading when taken singly, though they can be quite valuable when a small business tracks them over time or uses them as a basis for comparison against company goals or industry standards.

Perhaps the best way for small business owners to use financial ratios is to conduct a formal ratio analysis on a regular basis. The raw data used to compute the ratios should be recorded on a special form monthly. Then the relevant ratios should be computed, reviewed, and saved for future comparisons. Determining which ratios to compute depends on the type of business, the age of the business, the point in the business cycle, and any specific information sought.

For example, if a small business depends on a large number of fixed assets, ratios that measure how efficiently these assets are being used may be the most significant.

In general, financial ratios can be broken down into four main categories—1 profitability or return on investment; 2 liquidity; 3 leverage, and 4 operating or efficiency—with several specific ratio calculations prescribed within each.

  • On the other hand, a high ROI can mean that management is doing a good job, or that the firm is undercapitalized;
  • Entity ratios should not be compared with industry ratios.

Many entrepreneurs decide to start their own businesses in order to earn a better return on their money than would be available through a bank or other low-risk investments. If profitability ratios demonstrate that this is not occurring—particularly once a small business has moved beyond the start-up phase—then entrepreneurs for whom a return on their money is the foremost concern may wish to sell the business and reinvest their money elsewhere. However, it is important to note that many factors can influence profitability ratios, including changes in price, volume, or expenses, as well as the purchase of assets or the borrowing of money.

Some specific profitability ratios follow, along with the means of calculating them and their meaning to a small business owner or manager. It can be an indication of manufacturing efficiency, or marketing effectiveness. Strong gross profitability combined with weak net profitability may indicate a problem with indirect operating expenses or non-operating items, such as interest expense. In general terms, net profitability shows the effectiveness of management.

Though the optimal level depends on the type of business, the ratios can be compared for firms in the same industry. A very low return on asset, or ROA, usually indicates inefficient management, whereas a high ROA means efficient management. However, this ratio can be distorted by depreciation or any unusual expenses. Return on investment 1: Due to leverage, this measure will generally be higher than return on assets.

ROI is considered to be one of the best indicators of profitability. It is also a good figure to compare against competitors or an industry average. Experts suggest that companies usually need at least percent ROI in order to fund future growth.

If this ratio is too low, it can indicate poor management performance or a highly conservative business approach. On the other hand, a high ROI can mean that management is doing a good job, or that the firm is undercapitalized. Return on investment 2: It can be helpful in further comparison to the market price of the stock.

Although the ideal level for this ratio varies greatly, a very low figure may mean that the company maintains too many assets or has not deployed its assets well, whereas a high figure means that the assets have been used to produce good sales numbers. This ratio will vary widely from one industry to another.

  1. Analysis and interpretation of financial statement as a managerial tool for decision making a case study of nwokeji urban planning and. Ratio analysis, when performed regularly over time, can also help small businesses recognize and adapt to trends affecting their operations.
  2. In mature companies, low levels of liquidity can indicate poor management or a need for additional capital. The return on investment measure of performance.
  3. However, this ratio can be distorted by depreciation or any unusual expenses. Many entrepreneurs decide to start their own businesses in order to earn a better return on their money than would be available through a bank or other low-risk investments.
  4. Financial statement ratios support informed judgments and decision making most effectively when.

A high figure relative to one's industry average can indicate either good personnel management or good equipment. In other words, they relate to the availability of cash and other assets to cover accounts payable, short-term debt, and other liabilities. All small businesses require a certain degree of liquidity in order to pay their bills on time, though start-up and very young companies are often not very liquid.

In mature companies, low levels of liquidity can indicate poor management or a need for additional capital. Any company's liquidity may vary due to seasonality, the timing of sales, and the state of the economy. But liquidity ratios can provide small business owners with useful limits to help them regulate borrowing and spending. Some of the best-known measures of a company's liquidity include: Though the ideal current ratio depends to some extent on the type of business, a general rule of thumb is that it should be at least 2: A lower current ratio means that the company may not be able to pay its bills on time, while a higher ratio means that the company has money in cash or safe investments that could be put to better use in the business.

Quick ratio or "acid test": Ideally, this ratio should be 1: If it is higher, the company may keep too much cash on hand or have a poor collection program for accounts receivable.

If it is lower, it may indicate that the company relies too heavily on inventory to meet its obligations.

Financial statement ratios support informed judgement and decision making most effectively when

Cash to total assets: Although a high ratio may indicate some degree of safety from a creditor's viewpoint, excess amounts of cash may be viewed as inefficient. Sales to receivables or turnover ratio: A high number reflects a short lapse of time between sales and the collection of cash, while a low number means collections take longer. Because of seasonal changes this ratio is likely to vary.

As a result, an annual floating average sales to receivables ratio is most useful in identifying meaningful shifts and trends. This number should be the same or lower than the company's expressed credit terms. Other ratios can also be converted to days, such as the cost of sales to payables ratio. Cost of sales to payables: Lower numbers tend to indicate good performance, though the ratio should be close to the industry standard.

A high cash turnover ratio may leave the company vulnerable to creditors, while a low ratio may indicate an inefficient use of working capital. In general, sales five to six times greater than working capital are needed to maintain a positive cash flow and finance sales.

As a result, these ratios are reviewed closely by bankers and investors. Most leverage ratios compare assets or net worth with liabilities. A high leverage ratio may increase a company's exposure to risk and business downturns, but along with this higher risk also comes the potential for higher returns. Some of the major measurements of leverage include: Debt to equity ratio: A company is generally considered safer if it has a low debt to equity ratio—that is, a higher proportion of owner-supplied capital—though a very low ratio can indicate excessive caution.

  1. No single ideal ratio of core to total support can decision making to determining financial are to make informed programme decisions and.
  2. In general terms, net profitability shows the effectiveness of management.
  3. No single ideal ratio of core to total support can decision making to determining financial are to make informed programme decisions and.
  4. In the seller's records, the sale of merchandise on account would. Ratios are calculated by dividing one number by another, total sales divided by number of employees, for example.

In general, debt should be between 50 and 80 percent of equity. A debt ratio greater than 1. This ratio is similar, and can easily be converted to, the debt to equity ratio. Fixed to worth ratio: It is important to note that only tangible assets physical assets like cash, inventory, property, plant, and equipment are included in the calculation, and that they are valued less depreciation.

Creditors usually like to see this ratio very low, but the large-scale leasing of assets can artificially lower it. In general, a higher interest coverage ratio means that the small business is able to take financial statement ratios support informed judgement and decision making most effectively when additional debt.

This ratio is closely examined by bankers and other creditors. These ratios can show how quickly the company is collecting money for its credit sales or how many times inventory turns over in a given time period.

This information can help management decide whether the company's credit terms are appropriate and whether its purchasing efforts are handled in an efficient manner. The following are some of the main indicators of efficiency: Higher ratios—over six or seven times per year—are generally thought to be better, although extremely high inventory turnover may indicate a narrow selection and possibly lost sales.

A low inventory turnover rate, on the other hand, means that the company is paying to keep a large inventory, and may be overstocking or carrying obsolete items. Generally, a lower ratio is considered better.

Alternatively, the reciprocal of this ratio indicates the portion of a year's credit sales that are outstanding at a particular point in time. SUMMARY Although they may seem intimidating at first glance, all of the aforementioned financial ratios can be derived by simply comparing numbers that appear on a small busi-ness's income statement and balance sheet. Small business owners would be well-served by familiarizing themselves with ratios and their uses as a tracking device for anticipating changes in operations.

Financial ratios can be an important tool for small business owners and managers to measure their progress toward reaching company goals, as well as toward competing with larger companies.

Ratio analysis, when performed regularly over time, can also help small businesses recognize and adapt to trends affecting their operations.

Yet another reason small business owners need to understand financial ratios is that they provide one of the main measures of a company's success from the perspective of bankers, investors, and business analysts. Often, a small business's ability to obtain debt or equity financing will depend on the company's financial ratios. Despite all the positive uses of financial ratios, however, small business managers are still encouraged to know the limitations of ratios and approach ratio analysis with a degree of caution.

Ratios alone do not make give one all the information necessary for decision making. But decisions made without a look at financial ratios, the decision is being made without all the available data.