Ratio analysis is an effective way to understand the financial performance of a business. It involves calculating and analysing a series of financial ratios based on financial statements.
When combined with trend analysis (reviewing the pattern or trend of measures over time), ratio analysis provides powerful insights into the financial strength of the business.
There are many well-established ratios that can provide a good starting point for ratio analysis. Accountants, business advisers, industry bodies, banks and financial institutions are also good sources of ideas for ratios.
Three of the most useful are:
The keys to effective ratio analysis are:
- Use simple ratios that are quick and easy to extract
- Review ratios frequently regularly to keep your finger on the pulse.