Ratio Analysis - the most popular ratios explained..
When trying to analyse your company’s data it is a good idea to use ratio analysis.
We know there are so many ratios you could use and sometimes it can be quite overwhelming to decide which to use to correctly review your performance and provide the information you are looking for. This is why we have compiled a list of the most popular ratios below…
It is also worth mentioning that ratios are extremely useful when comparing company’s previous trading years and great to create trends for comparisons and/or industry averages to see how the company relates to others.
1. Net Profit Margin
Net profit margin is great for analysing company profitability. By considering this ratio you will be able to determine if the company is efficient in transferring the revenue into profit by controlling the costs connected with trade.
2. Return on Capital Employed
This is another helpful profitability ratio that measures how well the company uses its capital to create profit. In other words, this ratio will help with understanding if the capital which the company owns can be used more efficiently, causing profitability increase.
3. Quick Ratio
This ratio tests how well the current liabilities are covered by the current assets (except inventories as they are the longest to transfer into cash) in a case when the current liabilities need to be repaid.
As cash is extremely important in every company this ratio will allow an understanding of how close the company is to default. Moreover, it is a great measure of the company’s financial health.
4. Gearing Ratio (also known as a debt to equity ratio)
This ratio helps to understand the structure of how the company is financed. Too much debt may increase the risk for the company to default, due to high-interest payments and possibly a low amount of profit left over for paying dividends. However, a too low gearing ratio may mean that the company is losing with creating a tax shield – interest is tax-deductible – meaning their corporation tax will be higher.
5. Receivables, Payables, Inventory days
These ratios are great in measuring the company’s efficiency:
Receiving money from debtors – allows an understanding of how well the company’s credit policy is and the ability to chase the payment.
Paying the suppliers – paying too quickly may decrease the amount of money left for investment meaning there is a need for a balanced ratio.
How quickly the inventory is sold – long inventory days means the inventory sits for a really long time in the company manufacturing facilities which can cause it to go obsolete.
If you would like to find out more about ratio analysis, or how it can help your business. Please get in touch with us. We know these are difficult times so please do get in touch if you need would like to find out any more information.
Phone: 07541 644 536 / 01306 627 837