Ratio Analysis For A Small Business
Ratio analysis is a key tool to understand the potential and currentprofitability of any small business. There are different types offinancial ratios, all used for different purposes. In general, they tend tofall into three categories. The first category, that of liquidity ratiosare the standard measures of any business' financial health, and includethe business' standard and quick ratios. The standard current ratio for ahealthy business is two, meaning the business has twice as many assets asliabilities, as tracked monthly or quarterly. The quick or acid testliquidity ratio also measures a business' liquidity but excludes
The ROA ratio thus shows how much profit, before interest and income tax, abusiness has earned on the total capital used to make that profit. The return on assets ratio indicates how much the company is in debt bycomparing what is owed to what is owned. Thegross profits assets ratio thus shows the percentage of net sales remainingafter subtracting cost of goods sold. Thisratio is most useful when compared with the interest rate paid on thecompany's debt. Another efficiency ratio, the average collectionsperiod, indicates how quickly customers are paying bills by revealing theaverage length of the collection period. ("Financial Formulas for SmallBusinesses," 2003). Other examples of profitability ratios arethose of the ratios of inventory to net working capital ratio. It is most common to analyze profitability ratios in light of theperformance of industry peers. the business' assets and thus is considered amore stringent method of analysis. The gross profits assets ratio indicates how efficiently abusiness is using its materials and labor in the production process. The return on assets ratioindicates the business' profit on assets as test of capital utilization. It is usuallypreferable to run a business with as little inventory as possible on hand. ("Financial Formulas for SmallBusinesses," 2003) Efficiency ratios comprise a small business' cash flow, inventoryefficiency, and how quickly its products or services sell. Ideally, the average collectionsperiod will be less than the credit term agreed upon plus an additionalallowance of fifteen days. This ellshow much of a company's funds are tied up in inventory.
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