Financial Tools for Managers
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Managers Need the Right Tools
A characteristic of good tools is that they fit the job enabling the user to easily, efficiently, and successfully complete a project. Financial statements are recording tools providing the score for a business at a specific point in time. Getting the most out of the balance sheet, income statement, and cash flow statement is like learning how to use any tool properly, requiring a little guidance and some practice. Learning how to use these tools and interpreting the results will open up a whole new range of information or facts about the internal workings of a business. Understanding these new facts will provide a clearer picture of what is working and what is not ultimately leading to improved decision making. Financial analysis replaces assumptions, guesses, and partial information with solid facts making it more reliable a basis for making tough business choices.
Financial analysis results from slicing and dicing financial statements producing ratios that speak volumes about a business. The term “financial analysis” and “ratios” may sound intimidating but in the end all of these terms simply mean crunching numbers in a way that produces factual information on a businesses activity, leverage, profitability, and equity. The most familiar ratios, called profit margins, refer to both gross and net margins results from dividing operating profits by total sales or, in the case of net profit, dividing the actual bottom line by total sales. We all understand that a 4% net income means that 4% of total sales are left over after all business expenses have been met.
Understanding some basic financial ratios are powerful tools for both owners and managers revealing facts helpful to decision making but in establishing and measuring meaningful goals; taking absolute control of a business. The most well known liquidity ratios are the Quick (Acid-test Ratio) and Current ratios. Both are short-term indicators measuring a businesses’ ability to pay its current bills, bills due in less than one year, with current assets, assets that can be converted to cash in less than one year. The only difference between the Quick and Current ratios is inventory with the Quick ratio calculated without including inventory.
The Quick ratio specifically excludes inventory. This indicator measures the extent to which a company can pay current liabilities without relying on the sale of inventory. Typically, a Quick ratio of 1:1 or higher is good and indicates a company does not have to rely on the sale of inventory to pay the bills.
These ratios are also known as the working capital ratio and real ratio are the standard measure of a businesses financial health. It answers the question; do you have enough cash? For example, if a corporation has $50M in current assets to cover $50M in current liabilities, this means it has a 1:1 current ratio.
What is an acceptable current ratio? This varies by industry. Generally speaking, the more liquid the currents assets the smaller current ratio can be without cause for concern. For most companies, 1.5 is an acceptable current ratio keep in mind a greater spread translates into to a reduced risk and is a sure sign of good business health. A standard current ratio for a healthy business may be closer to two, meaning it has twice as many current assets as current liabilities. A good source for industry specific information is Risk Management and Associates, which completes annual financial statement studies and publishes the results.
There are a number of ratios that can be figured they measuring different aspects of a business. Learning how to use this tool box will improve your business. Using the right tool for the job makes completing any project easier and improves the finished product.
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Library of Congress Cataloging-in-Publication
Business/News & Views® / by David. W. Weatherholt
ISBN: 978-0-9823041-1-2 (electronic format)
Published in the United States of America through www.waconsult.com
Published in an electronic format by Weatherholt & Associates, LLC
First Trade Publishing: October 2008
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