Many business owners and company managers have found that insight gained from their examination of company financial statements can be invaluable. Such insight can help businesses improve their profitability, cash flow and value.
Ratio Analysis Is a Key Metric
One important tool that can help sort out the data you need is “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.
The bottom line is that ratio analysis can give you valuable feedback which, in turn, may yield profitable results for your business.
Higher Sales May Equal Higher Profits
Recent increases in a company’s sales figures may be impressive when viewed in isolation. However, business owners must take measures to ensure that the additional revenues are being translated into greater profits.
Net profit margin measures the proportion of each sales dollar that represents a profit, after taking into account all expenses. So, if a company’s margins aren’t keeping pace during sales growth periods, a thorough review of overhead and other expenses may be in order.
Focus On Accounts Receivable
Commonly, companies extend credit to their customers. As a result, a firm needs to keep a close watch on outstanding accounts so that slow payers can be contacted about past due amounts. From a broader view, knowing the company’s average collection period would be insightful. In general, the faster a company can collect money from its customers, the better its cash flow will be. However, management should also be aware that, if credit and collection policies are too restrictive, potential customers may decide to take their business elsewhere.
Efficiently Manage Inventory
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 also lead to cash flow issues. In contrast, a high turnover ratio is usually a good sign, unless inventory levels aren’t sufficient to fulfill customer orders in a timely manner.
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