Why Financial Ratios Matter: Our 3 Big Points

Financial ratios can be a pain and often feel like a foreign language. Here is our explainer of why financial ratios matter to you.

I’ll be spending the next week talking about financial ratios and going deep into the different types of ratios you might need to know about. We’ve already spoken about small business ratio terms that you’ll likely want to know, but that doesn’t get into the facts of the matter.

First, I’ll give you a sneak preview of next week’s big article about financial ratios and COVID. Then, I’ll get into a short reminder of how you can use financial ratios. Finally, the advantages of using financial ratios in the long run for any business

The Big Question: Why Do Financial Ratios Matter Anyways?

An article we’ve already written that we’ll be posting next week starts with this reminder. We think it’s a great way to learn about financial ratios on a large scale:

They can give us an easy way to gauge the health of our business. COVID and the botched reopening has pushed many small businesses to the brink of bankruptcy. To avoid this fate, it is important to focus on both liquidity and solvency. Ok, say what? In plain English, it’s all about having enough cash. How fast you can generate it, and do you have enough to pay your bills?

If this isn’t enough of an explanation, you should check out the full article for a complete breakdown of financial ratios and the different ways to understand them.

A Quick Explanation of What Financial Ratios Do

If I’ve done my job properly, you hopefully know the “why” behind financial ratios. That said, an encyclopedia article from Inc. has a lot of good answers to questions you might not have known to ask. One quote from their article, in particular, spoke to me as a small business owner myself.

Virtually any financial statistics can be compared using a ratio. In reality, however, small business owners and managers only need to be concerned with a small set of ratios in order to identify where improvements are needed...  

[T]hey can be quite valuable when a small business tracks them over time or uses them as a basis for comparison against company goals or industry standards.

This is a great way to think about what small businesses need ratios for. Financial ratios matter because they operate as a means of understanding what a company can offer.

As Inc. explains, your small business can use a financial ratio to ensure that the things that matter most are being targeted. You don’t want your small business to suffer due to a poor understanding of where your money is and how it is being spent. Instead, you can succeed by knowing what it is you need and how to achieve it.

What Are the Advantages?

Chron has a good write up from David Ingram about the advantages of financial ratios. If you’re concerned about how you can use financial ratios, what matters most is knowing why you’d want to use them. For one, a standard benchmark is a great way to make sure you know how you stack up to your competition.  

Also, as Ingram mentions, is measuring your growth and success relative to yourself. If you want to track performance, knowing why your financial ratios have changed will matter deeply. Overall, it isn’t just about having financial know-how; ratios help you keep your own business upright.

small business bank fear

In Summary...

Here are the three key points to remember:

  1. Financial ratios gauge the health of businesses. More than that, they help you know how much you have and how much you need at a given time.
  2. Know the different kinds of financial ratios. Different ratios have different purposes; you’ll want to know what helps you the most.
  3. The main reason that financial ratios are important? Tracking performance and benchmarks. Financial ratios are a great way to track how you’re doing across time.

Financial ratios matter because they can help your business stay afloat. Keep that in mind, and you’ll find success for your small business.

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About the Author

Brian Cairns, CEO of Prostrategix Consulting. Over 25 years of business experience as a corporate executive, entrepreneur, and small business owner. For more information, please visit my LinkedIn profile

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