Importance of Financial Ratios
The most important thing when we running a business is conducting financial ratio analysis. Before you go into the business world first you have to understand financial ratios, there are many benefits that you will get if you can analyze the financial ratios in your own business. You will find out how far your company is developing or just stay in place. If your financial ratios are good it will be a positive thing for your business and it will be easy to attract investors to join your business.
Financial ratios are a tool for analyzing and measuring company’s performance by using the company’s financial data. These financial data can be taken from financial statements such as profit or loss, balance sheet, and cash flow statement. Based on the purpose, the financial ratio is divided into 4:
- Profit Ratio
- Liquidity Ratio
- Solvability ratio
- Activity Ratio
Profit Ratio
Profability ratio will describe the company’s ability in terms of profit. From this ratio we will know how the company will survive. Profability ratio has 5 sizes that can be used to measure the number of profitability ratios.
- Gross Profit Margin
Gross profit margin is used to show gross profit that can be achieved from each sale. - Operating Profit Margin
The operating profit margin is used to show net income before interest and taxes that can be obtained from the company’s sales. - Net Profit Margin
The net profit margin is used to show the amount of net profit generated by each sale. - Return On Assets (ROA)
ROA is used to show the results of after tax operating profit from the total assets owned by the company. - Return On Investments (ROI)
ROI is used to show the ability of the company to generate profits that will be used to cover the investment spent.
Liquidity Ratio
The function of the liquidity ratio is to show the company’s ability to meet its short-term financial obligations, such as paying debts that are due, operating costs, employee wages, and others. There is a ratio that is often used to calculate this value
- Current Ratio
This ratio shows the comparison of current assets and current liabilities. The better the liquidity, the higher the value. - Quick Ratio
Quick ratio shows a comparison between (cash + short-term securities + accounts receivable) with current liabilities.
Solvability ratio
The function of the solvability ratio is to find out the company’s ability to fulfill all obligations both short and long term. To find out, there are 2 ratios to calculate
- Total Debt to Total Asset Ratio
This ratio is used to measure the amount of funds originating from debt. This illustrates how debt can be covered by company assets. - Debt to Equity Ratio
This ratio is used to measure debt that is owned by owner’s capital. Capital should always be higher than the debt that the company has.
Activity Ratio
The activity ratio is used to measure the level of active use or company wealth to the owner. From here the owner can see which assets are productive and which are not. Then the owner can decide to allocate funds to more productive assets.
- Receivable Turnover Ratio
This ratio is used to measure the effectiveness of accounts receivable management. The more effective the management, the higher the rotation. - Inventory Turnover Ratio
This ratio is used to show the company’s liquidity value in managing inventory, the higher the turnover it will have a good impact on the company. - Fixed Active Turnover Ratio
This ratio is used to measure a company’s ability to generate sales with its fixed assets. The greater the rotation, the better for the company. - Total Asset Turnover Ratio
This ratio is used to measure a company’s ability to generate sales. The greater the rotation, the better for the company
These are the description of financial ratios. From this explanation we will be able to assess the financial health of our business / company. And make sure our financial statements are complete and accurate in order to minimize unexpected costs.
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