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Financial Ratios Basics

Improve your company's fiscal fitness through the use of financial ratios basics

By Kelley Keith
In order to manage your business budget properly, you should understand the financial ratios basics. Financial ratios paint a positive or negative picture of the past, present and future of the company. Not only can these ratios help with your business, but they can also serve to compare it to other companies within the industry. With a list of financial ratios, it becomes much easier to see any fiscal problems that reside within the accounting ledger.

If you can master financial ratios basics, using and analyzing these figures will eventually become second nature. To a novice the terms liquidity, asset turnover and financial ratios can seem confusing. However, once you establish a basic knowledge of these ratios, your business will show marked fiscal improvement. Before you attempt to implement financial ratios, there are a few items that'll make the process much easier, such as:

1. Examine the definitions and uses of economic ratios.

2. Learn how to implement the financial ratios in the context of your business.

3. Calculate the money ratios using your business figures.

 

Review the basic purpose and definition of the standard financial ratios

To internalize financial ratios, it's best to start with the basic definition and computation. If you can begin to understand the derivation of each term, and how it relates to your company, then the real world application of each ratio becomes simpler.
Try: Use the business financial ratios explanation at NetMBA to define these computations. You can also visit the American Express website, which offers quizzes and tutorials about financial ratios.

Examine the real world applications of financial ratios

Simply memorizing a list of financial ratios isn't going to help you use these figures effectively. For example, liquidity ratios can help your business determine its creditworthy and cash position. However, if you only know the literal definition of the ratio, it'll be difficult to apply the ratio to help improve the company. Seeing these ratios used in a business context can help with this issue.
Try: Take the financial ratios tutorial at Investopedia. Use the Understanding Financial ratios from Money-zine.com to know how these ratios influence your company.

Input your business figures into financial ratio analysis software

In order to verify that you or your employees understand the process of computing financial ratios, use figures from your business in applications that compute the ratios. Financial ratio software provides a simple way to compute ratios once you know the derivation of each figure. This way you don't have to waste time setting up your own ratio models and, thus, it allows you to use financial ratios basics more easily.
Try: Employ the ratio calculator at Bankrate.com to determine the ratios for your business. Download the software available at MBAWare to get a better idea of how each financial ratio analysis software relates to each other.

 

  • When calculating financial ratios, it's important to perform the process at least twice. One misplaced number or decimal can give you an erroneous ratio. To take it a step farther, you should have another employee double check each financial ratio calculation before you make business decisions based on these figures.

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