Complete Guide To Corporate Finance

The Business Finance Guide

Those who own small businesses and want them to be financially successful should definitely take into consideration financial management and effective planning of their finances. In order to understand financial statements, it is mandatory to understand first what ratio analysis is and why it is very important for your business. Here is a useful information which you, as the owner of a company, should know when entering the business world.

What are financial ratios?

For those who are not quite familiar with the term, financial ratios are some elements used in analysing financial statements and evaluating the performance of a company. These ratios are used to present relationships between specific values within the financial statements. Since paying attention to one ratio only is of no use at all, it is recommended that more ratios should be examined at once and compared in order to obtain a picture of the company’s performance in relation to the performance of its other competitors in a market.

The importance of ratio analysis

Financial ratio analysis is highly important for evaluating a company’s performance and one of its main roles is to indicate both negative and the positive financial trends. The ratios in this case act as indicators of good or bad performance and the information they provide allow the owner of the company to implement certain financial plans and even make certain adjustments to the short-term financial plan if necessary. Another important role this analysis offers is the means with which to compare the assets and liabilities of a company. This is quite helpful for your company, because this way you can determine trends such as increasing accounts receivable balances or even decreasing cash for instance, which might help you understand the importance of strengthening the policy related to your accounts receivable collection. Cash and liquidity ratios help one to   make the right decision as to whether investing in capital assets is a good idea or whether one should rather consider long-term business growth.

Comparing a company’s performance using financial ratios

It is important to mention that the performance of a company can actually be compared to certain levels with the aid of these financial ratios and one great comparison example is by the industry in which the company operates. Ratios are used in this situation in order to make comparisons between the companies within the same industry. Another way in which these ratios can be used is to provide some analysis related to the historical performance of that company, which can be quite useful in determining the exact value of that firm. In this case, the specialists take the ratios of the current year and compare them with the ones of the previous year within the same company. Last but not the least, is the third method in which these financial ratios can be used which is cross sectional analysis. This implies comparing a company to other groups of companies while taking into account elements such as size or characteristics.

 

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