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You can use accounting ratios to see how your company’s finances progress over time or to benchmark your company against others in your sector. They are a useful indicator of how healthy your company is financially and can be used as an early warning signal.
Looking at just one ratio alone is not very helpful. You need to compare it with other values for it to mean anything. Here are some tips to help you get the most out of accounting ratios:
- Select a limited number of key ratios covering at least four financial years;
- Don’t change the formula you use to calculate the ratios – otherwise your figures won’t be comparable;
- Take into account any particularities of your sector.
For more information (in French only): fiche_info_ratios_comptables.pdf (95.6 kB)
The balance sheet provides a snapshot of your company’s assets. It summarizes, at a given point in time, the company’s assets and liabilities (which are, by definition, equal).
Assets refer to the resources available to the company to carry out its business. They are classified by degree of liquidity (i.e., availability) and broken down into current assets and fixed assets.
Liabilities represent claims against a company’s assets. They comprise equity and debt capital, and are ranked by seniority of the claims.
The rule of thumb is that the liquidity of assets should be consistent with the due dates of liabilities. In other words, current assets should be sufficient to cover short-term debt obligations (such as operating loans), and long-term liabilities (both debt and equity) should be sufficient to finance fixed assets.
Analyzing your accounts
There are different ways of analyzing your accounts, and the one or ones you use will depend on your goals, and the sector you are operating in and the market conditions. Here’s an overview of the main methods.
The aim here is to get an overview of how your company is changing over time. Each line item is analyzed individually over a specific period to try and spot patterns. By looking at trends over a given period, it is possible to understand what happened in the past, analyze the present and have a better idea of what could happen in the future.
This type of analysis aims to provide an overview of your company’s financial situation. It involves looking closely at the income statement, balance sheet and cash-flow statement and determining the weighting (as a %) of each item. Looking at each item on the income statement proportionally to turnover, for example, can help you to better understand the different margins (i.e., the commercial, operating and net margins).
A ratio shows the relationship between two amounts. The two amounts can come from the same statement (such as balance-sheet ratios) or be made up of items from different statements (such as profitability ratios). Ratios can be used to analyze financial profitability, economic profitability, leveraging, etc.
It can be useful to compare your company’s position to that of your competitors or to a sector benchmark. It is common to benchmark turnover, earnings, profitability, cash flows, capital expenditure, and working capital needs.
Cash flow analysis
This type of analysis looks at the various factors that affect the company’s cash position over a given period, which is usually a financial year. This is done by drawing up a cash-flow statement, which brings together all the relevant information on the three types of activities within a company – operations, investing and financing.