What is ratio analysis?
Ratio analysis will help you determine the relative strength of your organization in various parameters, such as liquidity, operational efficiency, etc. It is done by performing calculations on your cash flow statements, balance sheets, and income statements. Though it is done for competitive research by the investors, doing self ratio analysis can give you a lot of clarity about the financial health of your organization. These ratios will help you understand key areas in which your business needs to improve. So there are several tangible benefits of ratio analysis of your organization to get credible insights.
Industry Standards and Benchmarks
When you do a ratio analysis, you can predict and find certain industry standards and benchmarks that you should use to evaluate your organization. For instance, if the standard debt-to-equity ratio is 0.3 and your company is at 1.0, you need to reduce your debt-to-equity ratio to meet the industry standard. Therefore, you can make a complete operational strategy for your organization. And prepare your organization for future events.
Cash Flow Ratio’s: A Critical Metric to Measure Your Cash Flow
The cash flow ratio will help you to understand the liquidity of your organization. Along with that, it will give a sanity check for the long-term viability of the organization. There are various types of cash flow ratios that will give you an overview of different areas of your business:
- Current Liability Coverage Ratio: It is also known as the cash current debt ratio, and it measures the capital available to the business to clear its debt. So, the basic logic behind this ratio is that if the result of cash flow from operating activities divided by average current liabilities is less than one, then you cannot pay your current liabilities. On the other hand, if it is greater than one, it indicates that you can pay off your current debts.
- Cash flow coverage ratio: This ratio measures the capital an organization makes to pay its outstanding debt. So, if this ratio is more than one, then your business will not default on the loans. With a cash flow coverage ratio, lenders and banks determine whether a business is viable for a loan. Thus, you can check the eligibility for lending for your business using the same concept.
- Operating Cash Flow Ratio: This ratio measures all the cash flow generated by the selling activity from your business. Thus, if this ratio is more than one, it means your business is doing well overall financially because you are generating good cash flow.
Therefore, cash flow analysis is crucial for your business because it will give you an outside view of your business’s financial health. It will give you the statistics that you require to set the direction of your business. Apart from this, there are platforms like CredFlow that will help you to optimize your cash flow. It will streamline your account receivables, thus improving your working capital at the same time.
Planning and Performance with Ratio Analysis
As mentioned before, ratio analysis gives you an understanding of numerous areas in your business. Now, you can use those insights to create strategies that will help you to take your business to new heights. The main point of failure for businesses is poor cash flow management. So you have to take corrective measures if you are not reaching the industry standards and benchmarks for various ratios because if your cash flow declines, your working capital starts shrinking.
Therefore, doing a self-ratio analysis is crucial because it will help you create a roadmap for your organization and steer its direction for the forthcoming future.
Conclusion
Ratio analysis is not just a tool for investors and accountants of the third party. A self-ratio analysis of your organization can help you to understand key metrics of your financial health. There are tremendous benefits to doing ratio analysis in your organization that will give you tremendous insights into your business. It will help you create a baseline from which you can start your journey of expansion for better growth and cash flow.
