According to finance specialist, David Eckley financial ratios are a powerful tool that can be used to measure business performance.
"Financial ratios help to analyse the financial performance of all the activities of an organisation and all of its products and services in all markets."
Financial ratios are based on the balance sheet and profit and loss account in the organisation.
They allow for comparison between departments, companies and industries. Through this tool companies can assess and compare their past with their present performance.
It can also give insight into any financial constraints and possibilities linked to potential projects or activities.
However financial ratios should be used regularly and not merely to assess the viability of new projects.
"It is wise periodically to analyse the financial position and financial performance of every organisation."
According to Eckley there are 4 different types of financial ratios that reflect the performance of the organisation. These include:
Liquidity ratios - which indicate the extent to which a company is able to meet its financial obligations in the short term
Solvency ratios - which indicate the extent to which the company structurally meets all its financial obligations
Profitability ratios - which measure the earnings capacity of the current capital
Activity ratios - which show the turnover periods
But despite these benefits finance professionals need to note that ratios are only useful if they are benchmarked against something else.
In other words the ratios of firms in different industries, which face different risks, capital requirements, and competition can be hard to compare.
For more insights join "The importance of understanding financial language" course hosted by Alusani Skills & Training Network.
By Cindy Payle - Portal Publishing