Financial Ratios as Tools for Evaluating Corporate Performance

by Linda Ray

Ratios are important tools for evaluating your company’s performance. Ratios are determined by comparing various lines on your financial statements. You can use the ratios to identify red flags in a department’s performance or to determine how well your assets are being utilized. Ratios are useful for following individual job performances or overall corporate performance.

Uses

You can use financial ratios as tools to gauge your performance compared to how your company did in the past. The tools also are useful for providing comparative analyses of your corporate performance compared to your competitors. According to Zions Bank, financial ratios provide the same kind of analysis that batting averages do for baseball players. The methods are widely recognized by banks, Wall Street investment companies and other corporate financial professionals, providing common ground from which your company’s performance can be evaluated.

Types

One of the most common ratios used in business is the return on sales or net profit margin. You can use this ratio to determine your bottom line. For example, if your net profit margin is 10 percent, that indicates you earn 10 cents on every dollar of sales. Operating margin and gross profit margin are ratios that companies rely on regularly to measure the company’s performance. The gross margin measures how much you spend to generate each sale and the operating margin includes costs plus operating expenses. Other commonly used ratios include return on equity and return on assets. Return on equity measures the company’s performance compared to the stockholders’ investments and return on assets is a ratio that delivers performance ratings on your use of corporate assets.

Benefits

By relying on ratios consistently, you can spot trends and take action to remedy negative trends and possibly reallocate assets to boost positive trends. You’ll make more accurate decisions when they are based on dependable ratios. For example, if you see a continuing downward movement in your return on assets, you may have to look at your utility costs or how much you’re spending on marketing compared to your sales. Your return on assets ratio can tell you if too much of your cash is being tied up in credit, which you could remedy by increasing collection procedures or limiting new credit lines.

Features

In addition to the countless ratios you can develop from your financial statements, you can use ratios to get a quick look at your overall corporate performance at any point in time. The formula requires you to take your total current assets and subtract the value of your total current inventory. Divide that number by your current liabilities. By employing this quick ratio feature, you can quickly assess your company’s ability to meet its obligations under any circumstances. According to Zions Bank, a quick ratio figure between .5 and 1 is acceptable as long as you continue to make collections in a timely manner.

About the Author

Linda Ray is an award-winning journalist with more than 20 years reporting experience. She's covered business for newspapers and magazines, including the "Greenville News," "Success Magazine" and "American City Business Journals." Ray holds a journalism degree and teaches writing, career development and an FDIC course called "Money Smart."

Photo Credits

  • Hemera Technologies/AbleStock.com/Getty Images