Comparing key financial ratios for a business against industry standards and with its own past results can highlight trends and identify strengths and weaknesses in the business.
Financial statement information is most useful if owners and managers can use it to improve their company’s profitability, cash flow, and equity value. Getting the most mileage from financial statement data requires some analysis.
One analytical approach is called ratio analysis. Ratio analysis looks at the relationships between key numbers on a company’s financial statements. After the ratios are calculated, they can be compared to industry standards — and the company’s past results, projections, and goals — to highlight trends and identify strengths and weaknesses.
In many franchise agreements, key accounting ratios might be specified in the franchise contract terms as performance metrics or key performance indicators (KPI) — or they may be stated less rigorously as performance goals: such as, “If you expect to make X% profit as a franchisee, you will need to keep your labor expenses at lower than 50% of gross sales…” At the same time, the franchise agreement might require (or just recommend) that bookkeeping and accounting expenses not exceed Y% of administrative overhead costs — which makes for all the more reason why a franchisee would want to hire a reliable, cost-efficient, expert accounting service that really understands ratio analysis — such as Baum CPA.
If you are the proud entrepreneur-investor-founder-owner-manager of a ROBS arrangement C-Corporation venture that is not a franchise, you will be faced at first with an absence of key accounting ratios and prescribed KPIs. It is strongly advisable in launching such an enterprise to do in-depth market research into expected comparables, and engage the services of a reliable, cost-efficient, expert accounting service that really understands ratio analysis — such as Baum CPA. In addition to our extensive yet affordable experience in setting up the accounting environment for ROBS arrangements, we know how to find out the competitive market baselines for comparable KPIs among countless industry niches, and how to translate that research into practical, actionable advice for your successful ROBS operations! Better still, why not click here to schedule a consultation appointment today?
Here are some examples to illustrate how ratio analysis can provide valuable feedback to company decision-makers.
Do Rising Sales = Rising Profits?
The Chickenfeather Organic Sock Company has been experiencing impressive increases in their sales figures for a few months now. But the owners aren’t certain that the additional revenues are translating into better profits. Net profit margin measures the proportion of each sales dollar that flows through to the “bottom line” after taking into account ALL expenses. Every sale comes with both direct costs (e.g., materials, inventory, production labor, production machinery use) and indirect costs (e.g., advertising, rent and physical plant overhead — including idle machinery, office overhead, website & internet). If the company profit margins aren’t holding up during growth periods, a hard look at overhead expenses may be in order — especially space and equipment utilization and possible inefficiencies in production capacity or ordering fulfillment.
Candelabras-Я-Us extends credit to the majority of its customers for their line of elegant, designer candelabras. The firm keeps a close watch on outstanding accounts so that slow payers can be contacted. From a broader perspective, knowing the company’s average collection period would be useful. In general, the faster Candelabras-Я-Us can collect money from its customers, the better its cash flow will be. But their management should also be aware that if credit and collection policies are made too restrictive — to try to reduce the carrying cost of unpaid receivables — potential customers may decide to take their business elsewhere. Comparative research into the credit terms of competitors and comparable companies in the market would elevate the competitive position of Candelabras-Я-Us.
The Wizard Runestones & Magical Artifacts Boutique carries several product lines — some of which are insanely popular, others are precious objects with a very high markup, and bunches of stuff that are not high-demand or very profitable, but emphasize and accessorize the character and reputation of the business brand. Inventory turnover measures the speed at which inventories are sold. A slow turnover ratio relative to industry standards may indicate that stock levels are excessive. The excess money tied up in inventories could be used for other purposes. Or it could be that inventories simply aren’t moving, and that could lead to cash problems. In contrast, a high turnover ratio is usually a good sign — unless quantities aren’t sufficient to fulfill customer orders in a timely way. The Wizards who own and manage their Runestones & Magical Artifacts Boutique could benefit from some serious ratio analysis rather than just relying on their surplus inventory of crystal balls.
Expert Bookkeeping and Accounting Services
Whatever challenging business you own and manage, your financial operations and bottom line will benefit from the knowledgeable, expert services and support provided by the professionals at Baum CPA. Far above and beyond just ordinary bookkeeping and accounting services, our expertise will help in the preparation and analysis of financial statements with continuing business advisory updates to help you reach higher levels of managerial business success. Why not contact us — The Accounting Professionals at Baum CPA — to set up your appointment? Simply click here!
This blog and its authors provide this content strictly for informational purposes. No content herein should be misconstrued as financial advice. Everyone’s specific circumstances vary — Always consult with a qualified, licensed financial advisor, legal counsel, and tax professional before venturing into any investment or business activities.