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An Overview of Financial Ratio Analysis

Ratio Analysis is a Powerful Financial Analysis Tool for Your Firm

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Financial ratio analysis is one tool of investigating and comparing relationships between different pieces of financial information. You use information from the income statement and balance sheet to calculate financial ratios in order to determine information about your small business firm. There are any number of ratios you could calculate. To solve that problem, there are some standard ratios that most business firms use.

The problem with ratios is that they are useless unless they are compared to something. For example, if you calculate your firm's debt ratio for one time period (let's say a year) and it's 50%. What does that really mean? All you can take from that is that, since the debt ratio is Total Liabilities/Total Assets, 50% of your firm's assets are financed by debt. You don't know if that is good or bad unless you have something to compare that 50% to.

Trend and Industry Analysis

That's where trend (time-series) and industry (cross-sectional) analysis come in. You can compare your firm's ratios to trend data, which is data from other time periods for your firm, to see how your firm is doing over a series of time periods.

You can also compare your firm's ratios to industry data. You can gather data from similar firms in the same industry, calculate their financial ratios, and see how your firm is doing compared to the industry at large. Ideally, to get a good picture of the financial picture of your firm, you should do both.

Articles and Resources to Help You

Here are some articles, FAQs, and resources to help you complete financial ratio analysis for your business.

  • This is the introduction to the FAQ on the asset management or asset utilization (turnover) ratios.

  • Use Asset Management Ratios in Financial Analysis
  • This is an article on asset management or efficiency ratios. All the relevant asset management ratios are explained and calculated.

    This is a calculation and explanation of all the most often used profitability ratios.

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