This information helps you determine how much financing your business needs and helps outsiders determine whether lending you money or investing in your business is a wise use of their funds. You'll probably also want to note any personal seed capital your business has, or will have. Financiers want and often require entrepreneurs to put their own funds in the venture, and the greater the portion you commit relative to your net worththe better. You must also determine which type of financing would be most suitable for your business.
Examples include such often referred to measures as return on investment ROIreturn on assets ROAand debt-to-equity, to name just three.
These ratios are the result of dividing one account balance or financial measurement with another. Financial ratios can provide small business owners and managers with a valuable tool with which to measure their progress against predetermined internal goals, a certain competitor, or the overall industry.
In addition, tracking various ratios over time is a powerful means of identifying trends in their early stages. Ratios are calculated by dividing one number by another, total sales divided by number of employees, for example.
Ratios enable business owners to examine the relationships between items and measure that relationship. They are simple to calculate, easy to use, and provide business owners with insight into what is happening within their business, insights that are not always apparent upon review of the financial statements alone.
Ratios are aids to judgment and cannot take the place of experience. But experience with reading ratios and tracking them over time will make any manager a better manager.
Ratios can help to pinpoint areas that need attention before the looming problem within the area is easily visible. Virtually any financial statistics can be compared using a ratio.
In reality, however, small business owners and managers only need to be concerned with a small set of ratios in order to identify where improvements are needed. It is important to keep in mind that financial ratios are time sensitive; they can only present a picture of the business at the time that the underlying figures were prepared.
For example, a retailer calculating ratios before and after the Christmas season would get very different results. In addition, ratios can be misleading when taken singly, though they can be quite valuable when a small business tracks them over time or uses them as a basis for comparison against company goals or industry standards.
Perhaps the best way for small business owners to use financial ratios is to conduct a formal ratio analysis on a regular basis. The raw data used to compute the ratios should be recorded on a special form monthly. Then the relevant ratios should be computed, reviewed, and saved for future comparisons.
Determining which ratios to compute depends on the type of business, the age of the business, the point in the business cycle, and any specific information sought. For example, if a small business depends on a large number of fixed assets, ratios that measure how efficiently these assets are being used may be the most significant.
In general, financial ratios can be broken down into four main categories—1 profitability or return on investment; 2 liquidity; 3 leverage, and 4 operating or efficiency—with several specific ratio calculations prescribed within each. Many entrepreneurs decide to start their own businesses in order to earn a better return on their money than would be available through a bank or other low-risk investments.
If profitability ratios demonstrate that this is not occurring—particularly once a small business has moved beyond the start-up phase—then entrepreneurs for whom a return on their money is the foremost concern may wish to sell the business and reinvest their money elsewhere. However, it is important to note that many factors can influence profitability ratios, including changes in price, volume, or expenses, as well as the purchase of assets or the borrowing of money.
Some specific profitability ratios follow, along with the means of calculating them and their meaning to a small business owner or manager. It can be an indication of manufacturing efficiency, or marketing effectiveness.
Strong gross profitability combined with weak net profitability may indicate a problem with indirect operating expenses or non-operating items, such as interest expense.
In general terms, net profitability shows the effectiveness of management. Though the optimal level depends on the type of business, the ratios can be compared for firms in the same industry. A very low return on asset, or ROA, usually indicates inefficient management, whereas a high ROA means efficient management.
However, this ratio can be distorted by depreciation or any unusual expenses. Return on investment 1:The financial part of a business plan includes various financial statements that show where your company currently stands and where it expects to be in the near future.
This information helps you. Elizabeth Wasserman is editor of Inc.'s technology website, you may also include a business financial history as part of the financial section.
More than free sample business plans. The financial analysis section of your business plan should contain the data for financing your business now, what will be needed for future growth, and an estimation of your operating expenses.
The financial part of a business plan includes various financial statements that show where your company currently is financially, and where it intends to be. This information helps you determine.
Business Ratios The following table outlines some of the more important ratios from the Portfolio Fund Managing industry. The final column, Industry Profile, details specific ratios based on the industry as it is classified by the NAICS code, A ratio of or higher is a comfortable financial position for most enterprises.
Current Liabilities to Net Worth – a measure of the extent to which the enterprise is using creditor funds versus their own investment to finance the business (Current Liabilities / Liabilities + Equity).