How do you use your company?s financial statements? In many cases, owners and managers find that the insights they gain from their financial statements can improve their company?s profitability, cash flow, and value.
One important tool that can help sort out the data you need is ?ratio analysis.? Ratio analysis looks at the relationships between key numbers on a company?s financial statements. After the ratios are calculated, they can be compared to industry standards ? and the company?s past results, projections, and goals ? to highlight trends and identify strengths and weaknesses.
The hypothetical situations that follow illustrate how ratio analysis can give you valuable feedback.
Do Higher Sales Mean Higher Profits?
The recent increases in Company X?s sales figures have been impressive. But the owners aren?t certain that the additional revenues are being translated into profits. Net profit margin measures the proportion of each sales dollar that represents a profit, after taking into account all expenses. So, if Company X?s margins aren?t holding up during growth periods, a hard examination of overhead expenses may be in order.
Are We Getting Paid?
Company Y extends credit to the majority of its customers. So the firm keeps a close watch on outstanding accounts so that slow-payers can be contacted. From a broader perspective, knowing the company?s average collection period would be useful. In general, the faster Company Y can collect money from its customers, the better its cash flow will be. But Company Y?s management should also be aware that, if credit and collection policies are too restrictive, potential customers may decide to take their business elsewhere.
Is Inventory Being Managed Efficiently?
Company Z has several product lines. Inventory turnover measures the speed at which inventories are sold. A slow turnover ratio relative to industry standards may indicate that stock levels are excessive. The excess money tied up in inventories could be used for other purposes. Or it could be that inventories simply aren?t moving, and that could lead to cash problems. In contrast, a high turnover ratio is usually a good sign ? unless quantities aren?t sufficient to fulfill customer orders in a timely way.
These are just some examples of ratios that may be meaningful to you. If you?d like to learn more, contact our firm today.
PCPS Express is prepared by Newkirk Products, Inc. for the exclusive use of its subscribers. The information provided in the newsletter has been obtained from sources believed to be reliable but its accuracy is not guaranteed. The newsletter is not reviewed by any representative or component of the AICPA or the Private Companies Practice Section.
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