Forgive me. I like financial ratios. I also like cash flow forecasting and even budgeting, but we’ll talk about that later. The reason I like financial ratios is because they provide meaning to financial statements. Who among us hasn’t looked at a set of financial statements and wondered, “Ok, but what does all this mean?” I can’t give you the answer, but I can give you the tools to help you find the answer.
Financial ratios are typically divided into four categories.
- Liquidity ratios measure an organization’s cash availability to pay its short-term debt
- Activity (or efficiency) ratios measure the ability to convert non-cash assets into cash
- Debt (or solvency) ratios measure a business’s ability to pay its long-term debt
- Profitability ratios help measure management’s ability to provide a return to ownership
Within each of these categories are dozens of ratios and calculations. In fact there are so many ratios that it’s easy to get lost in them rather than focusing on what the ratios are telling you. If you’ve gotten to that point, stop. Fully understanding only a handful of ratios is far better than general awareness of them all. In a later post we’ll go through some of the most basic ratios from each category.
About the Author
Geoff Chinnock is a consultant with Morrison, working primarily in our Business & Accounting Advisory practice. To get in touch with Geoff, please find contact information for Morrison here.