Key Financial Analysis Metrics for Your Business
While many business owners and company managers might groan at the thought of studying their company’s financial statements, the truth is that these documents can reveal vital insights about a business. From improved profitability and better cash flow to higher overall value, the benefits of financial analysis are manifold. Read on to learn about some different metrics for analyzing your financial statements and the important insights they can reveal.
Ratio Analysis
Ratio analysis is a great method for parsing the data contained in your company’s financial statements. This key metric offers insight into the relationships between the various items on your statements. First calculate your firm’s various ratios, then compare them with your company’s past results, projections, and goals, as well as with industry standards. Ratio analysis helps you highlight key trends, determine where your company stands, and identify various strengths and weaknesses.
Inventory Turnover Rate
Your firm’s inventory turnover rate indicates the speed of sale of your inventories. Sometimes, a relatively slow turnover rate indicates excessive stock levels—meaning that you have excess money tied up in inventories and, therefore, unavailable for other purposes. Alternatively, a slow turnover rate might indicate that your inventories simply aren’t moving—a problem that can easily lead to cash flow issues. A high inventory turnover rate is generally a good sign; however, trouble can arise if your inventory levels aren’t sufficient to fulfill customer orders in a timely fashion.
Average Accounts Receivable Collection Period
It’s helpful to have a general idea of your firm’s average collection period, in order to make strategic planning easier. While it is a standard practice for companies to extend credit to their customers, businesses that do so must be sure to stay on top of all outstanding accounts. From the cash flow side, it is generally preferable to have a relatively shorter collection period; however, you should be careful not to drive away potential customers with overly strict credit and collection policies.
Net Profit Margin
Net profit margin is a measure of the fraction of each sales dollar that represents a profit, after all expense are accounted for. While it’s easy to tout a recent increase in your company’s sales figures, the true measure of success is whether your additional revenues lead to greater profits. Pay close attention to your company’s margins in the midst of sales growth periods to ensure that they are keeping pace. If not, consider reviewing your overhead and other expenses.
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