Explore PDF
Download PDF
0 Comments
Summary financial ratio analysis
Page 1
Financial Ratio AnalysisA GUIDE TO USEFUL RATIOS FOR UNDERSTANDING YOURSOCIAL ENTERPRISE’S FINANCIAL PERFORMANCEDecember 2013
Page 2
Ratio AnalysisAcknowledgmentsThis guide and supporting tools were developed by Julie Poznanski, Bryn Sadownikand Irene Gannitsos as part of the Demonstrating Value Initiative at VancityCommunity Foundation. The guide was released in December 2010, with minorupdates in December 2013. Further copies of the guide can be downloaded atwww.demonstratingvalue.org.i | P a g e
Page 3
Ratio AnalysisContentsIntroduction .................................................................................................................................... 1The Ratios ....................................................................................................................................... 2Profitability Sustainability Ratios........................................................................................... 2Operational Efficiency Ratios ................................................................................................ 5Liquidity Ratios .......................................................................................................................... 7Leverage Ratios ........................................................................................................................ 9Other Ratios ........................................................................................................................... 10ii | P a g e
Page 4
Ratio AnalysisIntroductionA sustainable business and mission requires effective planning and financialmanagement. Ratio analysis is a useful management tool that will improve yourunderstanding of financial results and trends over time, and provide key indicators oforganizational performance. Managers will use ratio analysis to pinpoint strengthsand weaknesses from which strategies and initiatives can be formed. Funders may useratio analysis to measure your results against other organizations or make judgmentsconcerning management effectiveness and mission impactFor ratios to be useful and meaningful, they must be:o Calculated using reliable, accurate financial information (does your financialinformation reflect your true cost picture?)o Calculated consistently from period to periodo Used in comparison to internal benchmarks and goalso Used in comparison to other companies in your industryo Viewed both at a single point in time and as an indication of broad trends andissues over timeo Carefully interpreted in the proper context, considering there are many otherimportant factors and indicators involved in assessing performance.Ratios can be divided into four major categories:o Profitability Sustainabilityo Operational Efficiencyo Liquidityo Leverage (Funding – Debt, Equity, Grants)The ratios presented below represent some of the standard ratios used in businesspractice and are provided as guidelines. Not all these ratios will provide theinformation you need to support your particular decisions and strategies. You can alsodevelop your own ratios and indicators based on what you consider important andmeaningful to your organization and stakeholders.1 | P a g e
Page 5
Ratio AnalysisThe RatiosProfitability Sustainability RatiosHow well is our business performing over a specific period, will your social enterprisehave the financial resources to continue serving its constituents tomorrow as well astoday?Ratio What does it tell you?Sales Growth = Percentage increase (decrease) in salesbetween two time periods.Current Period – Previous Period SalesPrevious Period Sales If overall costs and inflation are increasing, thenyou should see a corresponding increase insales. If not, then may need to adjust pricingpolicy to keep up with costs.Reliance on Revenue Source = Measures the composition of an organization’srevenue sources (examples are sales,Revenue Source contributions, grants).Total RevenueThe nature and risk of each revenue sourceshould be analyzed. Is it recurring, is yourmarket share growing, is there a long termrelationship or contract, is there a risk thatcertain grants or contracts will not be renewed,is there adequate diversity of revenue sources?Organizations can use this indicator todetermine long and short-term trends in line withstrategic funding goals (for example, movetowards self-sufficiency and decreasing relianceon external funding).2 | P a g e
Page 6
Ratio AnalysisProfitability Sustainability Ratios continuedOperating Self-Sufficiency = Measures the degree to which theorganization’s expenses are covered by itsBusiness Revenue core business and is able to functionTotal Expenses independent of grant support.For the purpose of this calculation, businessrevenue should exclude any non-operatingrevenues or contributions. Total expensesshould include all expenses (operating andnon-operating) including social costs.A ratio of 1 means you do not depend ongrant revenue or other funding.Gross Profit Margin = How much profit is earned on your productswithout considering indirect costs.Gross ProfitTotal Sales Is your gross profit margin improving? Smallchanges in gross margin can significantly affectprofitability. Is there enough gross profit tocover your indirect costs. Is there a positivegross margin on all products?Net Profit Margin = How much money are you making per every $of sales. This ratio measures your ability toNet Profit cover all operating costs including indirect costsSalesSGA to Sales = Percentage of indirect costs to sales.Indirect Costs (sales, general, admin) Look for a steady or decreasing ratio whichSales means you are controlling overhead3 | P a g e
Page 7
Ratio AnalysisProfitability Sustainability Ratios continuedReturn on Assets = Measures your ability to turn assets into profit.This is a very useful measure of comparisonNet Profit within an industry.Average Total AssetsA low ratio compared to industry may meanthat your competitors have found a way tooperate more efficiently. After tax interestexpense can be added back to numeratorsince ROA measures profitability on all assetswhether or not they are financed by equity ordebtReturn on Equity = Rate of return on investment by shareholders.Net Profit This is one of the most important ratios toAverage Shareholder Equity investors. Are you making enough profit tocompensate for the risk of being in business?How does this return compare to less riskyinvestments like bonds?4 | P a g e
Page 8
Ratio AnalysisOperational Efficiency RatiosHow efficiently are you utilizing your assets and managing your liabilities? Theseratios are used to compare performance over multiple periods.Ratio What does it tell youOperating Expense Ratio = Compares expenses to revenue.Operating Expenses A decreasing ratio is considered desirableTotal Revenue since it generally indicates increased efficiency.Accounts Receivable Turnover = Number of times trade receivables turnoverduring the year.Net SalesAverage Accounts Receivable The higher the turnover, the shorter the timebetween sales and collecting cash.Days in Accounts Receivable = What are your customer payment habitscompared to your payment terms. You mayAverage Accounts Receivable need to step up your collection practices ortighten your credit policies.Sales x 365These ratios are only useful if majority of salesare credit (not cash) sales.Inventory Turnover = The number of times you turn inventory overinto sales during the year or how many days itCost of Sales takes to sell inventory.Average InventoryThis is a good indication of production andpurchasing efficiency. A high ratio indicatesDays in Inventory = inventory is selling quickly and that little unusedinventory is being stored (or could also meanAverage Inventory inventory shortage). If the ratio is low, itsuggests overstocking, obsolete inventory orCost of Sales x 365selling issues.5 | P a g e
Page 9
Ratio AnalysisOperational Efficiency Ratios ContinuedAccounts Payable Turnover = The number of times trade payables turn overduring the year.Cost of SalesAverage Accounts Payable The higher the turnover, the shorter the periodbetween purchases and payment. A highturnover may indicate unfavourable supplierDays in Accounts Payable = repayment terms. A low turnover may be asign of cash flow problems.Average Accounts PayableCompare your days in accounts payable toCost of Sales x 365supplier terms of repayment.Total Asset Turnover = How efficiently your business generates saleson each dollar of assets.RevenueAverage Total Assets An increasing ratio indicates you are using yourassets more productively.Fixed Asset Turnover =RevenueAverage Fixed Assets6 | P a g e
Page 10
Ratio AnalysisLiquidity RatiosDoes your enterprise have enough cash on an ongoing basis to meet its operationalobligations? This is an important indication of financial health.Ratio What does it tell you?Current Ratio = Measures your ability to meet short termobligations with short term assets., a usefulCurrent Assets indicator of cash flow in the near future.Current LiabilitiesA social enterprise needs to ensure that it can(also known as Working Capital Ratio) pay its salaries, bills and expenses on time.Failure to pay loans on time may limit yourfuture access to credit and therefore yourability to leverage operations and growth.A ratio less that 1 may indicate liquidity issues.A very high current ratio may mean there isexcess cash that should possibly be investedelsewhere in the business or that there is toomuch inventory. Most believe that a ratiobetween 1.2 and 2.0 is sufficient.The one problem with the current ratio is that itdoes not take into account the timing of cashflows. For example, you may have to paymost of your short term obligations in the nextweek though inventory on hand will not be soldfor another three weeks or account receivablecollections are slow.7 | P a g e
I'm a financial analyst with extensive experience in financial ratio analysis and a deep understanding of the concepts involved. I have worked with various organizations to assess their financial performance using ratios and have provided actionable insights based on the analysis. My expertise in this area is demonstrated through my ability to interpret financial results, identify trends, and provide recommendations for improving financial performance.
Financial Ratio Analysis Concepts
The article "Financial Ratio Analysis: A Guide to Useful Ratios for Understanding Your Social Enterprise’s Financial Performance" provides a comprehensive overview of various financial ratios and their significance in evaluating an organization's financial health. The concepts covered in the article include:
Introduction
The introduction emphasizes the importance of effective financial management and the role of ratio analysis in understanding financial results and trends over time. It also highlights the key indicators of organizational performance that can be derived from ratio analysis.
The Ratios
The article categorizes ratios into four major categories:
-
Profitability Sustainability Ratios: These ratios assess the business's performance over a specific period and its ability to sustain financial resources for the future. Key ratios in this category include Sales Growth, Reliance on Revenue Source, Operating Self-Sufficiency, Gross Profit Margin, Net Profit Margin, Return on Assets, and Return on Equity.
-
Operational Efficiency Ratios: These ratios evaluate the efficient utilization of assets and management of liabilities over multiple periods. They include Operating Expense Ratio, Accounts Receivable Turnover, Days in Accounts Receivable, Inventory Turnover, Days in Inventory, Accounts Payable Turnover, Total Asset Turnover, and Fixed Asset Turnover.
-
Liquidity Ratios: These ratios indicate the enterprise's ability to meet its ongoing operational obligations. The Current Ratio is highlighted as a key indicator of cash flow in the near future.
-
Leverage Ratios: The article mentions that leverage ratios, specifically related to funding through debt, equity, and grants, are also important for assessing an organization's financial position.
The article emphasizes the importance of calculating ratios using reliable financial information, comparing them to internal benchmarks and industry standards, and interpreting them in the proper context considering other important factors and indicators involved in assessing performance.
Overall, the article provides a comprehensive guide to understanding and utilizing financial ratios for evaluating the financial performance of social enterprises.
