Importance of financial statement ratios

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revenue recognition, accounting standardMonthly financial reports are a management way of obtaining a concise overview of the previous month’s financial wellbeing and performance. When reviewing these reports, there are common ratios that can give you insight into your company’s liquidity, financial leverage, and the overall efficiency of assets used, which can help when making future plans and decisions.

One of the quickest ways to get an assessment of your company’s health is by understanding its liquidity. Two of the most common ratios used for assessing liquidity are the working capital ratio and the acid test ratio. The working capital ratio, otherwise known as the current ratio, is the core indication of a business’s short term financial health and is calculated by dividing all current assets by current liabilities to show how easily the company can turn assets into cash to pay all short term obligations. In addition, the acid test ratio, otherwise known as the quick ratio, subtracts inventories from the current assets before dividing that figure by the current liabilities. The idea of the acid test ratio is to show how well current liabilities are covered by cash and by items with ready value.

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A common ratio used to determine a company’s financial leverage is the debt-to-equity ratio. This ratio is calculated by dividing your company’s total liabilities by its equity. This ratio is important because it reflects the ability of your company to cover all the outstanding debt with the equity in the event of a business downturn.

Finally, a common ratio used to review how the overall efficiency of your company’s assets is by using the return on assets ratio. The return on assets ratio is calculated by taking net income and dividing it by total assets to indicate how well your company is utilizing its assets based upon how profitable the company is relative to its total assets. Having a high return on assets ratio indicates more asset efficiency.

Reviewing financial reports and understanding these common financial ratios will help decipher the crucial financial information that covers a specified period through daily, weekly, and monthly financial reports. These are powerful tools that can be applied to help evaluate and monitor business performance.  Even if these ratios are not the best for your company, there are others that very well may be. Before producing your same old monthly financial reports, consider performing a checkup to see how your financial reporting can be improved with the inclusion of financial ratios that are important to your company.

As always, feel free to contact us with any questions.

Spencer Saing