Getting business insight through financial analysis is critical for any business organization. The financial performance is the overall result of all your company’s initiatives and organization wide functions and activities from sales and marketing to HR and operations. While measuring and monitoring all business functions is important for management to measure success and take necessary actions on time, the financial reporting and analysis is a must have for every company.
Having said that it is important to use a proper planning and evaluation of the financial reporting requirements for your business. The question is what are the financial data, information, ratios and metrics which are necessary to be monitored on a continuous basis in order to understand what drives our key performance indicators and overall organizational success.
The most important source of information in financial reporting are the three basic financial statements: your income statement or profit and loss (P&L) statement, your balance sheet and your cash flow statement. Most of the financial ratios on your financial dashboard report will use the data available in these three statements.
The question is what financial ratios should we use. Before you go deep into details you need to plan your financial ratio analysis report. All the financial ratios you’ll use are part of the 5 main categories in financial analysis.
These 5 main categories of ratios are:
1. Profitability ratios (example: gross profit margin, net profit margin, ROE)
Profitability ratios measure the company’s ability to generate profit and takes into account the margins, costs and expenses of operating the business. The higher these numbers the more profitable the business is.
2. Operating ratios (example: asset turnover, inventory turnover)
Operating ratios measure the company’s efficiency and productivity. This group of financial ratios compares costs and expenses to sales and profit margins to evaluate the organizational efficiency.
3. Cash flow ratios (example: cash / sales, operating cash flow ratio, cash flow coverage)
Cash flow ratios measure the company’s ability to generate and manage cash from operations, investing and financing.
4. Liquidity ratios (example: current ratio, quick ratio)
Liquidity ratios monitor and measure the company’s liquidity or how able is the company to pay its short-term debt on time.
5. Debt ratios (example: interest coverage, cash to debt)
Debt ratios measure the company’s debt and compares it with the company’s equity and assets. The financial leverage and risk shows how able is the company to pay its principal debt, interest and other payments.
While most managers measure profit margins, it is also equally important to measure cash flow, debt, liquidity and operating performance in order to develop and manage a successful business both in short term and long term future.
By focusing on these five groups of financial ratios you’ll be able to create and manage an effective ratio analysis report. The key is to measure, track and analyze continuously your most relevant ratios in each of these categories and you make sure you focus on all the important financial areas in your business.
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