Sundaymail EditorBUSINESSES usually generate financial reports at the end of each month, quarter and annually.
Reports such as the statement of profit and loss and other comprehensive income and statement of financial position create a snapshot of how a business is functioning.
However, a quicker view of a business’s financial health and pinpointing specific aspects of a business can only be possible through financial ratios.
And it is these ratios that indicate what is working within a business and what is not.
Ratios such as liquidity ratios, profitability ratios, debt ratios, operating performance ratios, cash-flow indicator ratios and investment valuation ratios can help business leaders identify potential problems before they happen.
Even though all these ratios are important, a business leader must at the very least be acquainted to liquidity and profitability ratios.
For example, liquidity ratios like the current ratio can help business leaders assess both their liquidity position and working capital. On profitability ratios, a business leader should at least know his or her return on investment ratio (ROI) and return on equity (ROE).
They indicate whether one is actually gaining or losing on their investments.
Just as doctors use medical checkups to assess the condition of one’s health, market watchers also use various ratios to check on the health of the business in the financial world.
They are usually benchmarked to the best performing company in a particular market segment. Econet, for instance, can compare their ratios with Vodacom.
Even if you are still a small player in the industry, always benchmark yourself with the best.
If you cannot calculate these ratios, you will need to rope in the services of experts to assist you. You surely need to know the status of your business.
Calculating the return on investment of a business can be quite intriguing. Typically, the ROI can tell you how much money you are gaining or losing on every dollar that you spend.
All this information helps management in the decision making process.
Over the years, I have observed that most entrepreneurs are not good at managing their own businesses. Indeed, they have the acumen to do major deals and expand, but it is a different story when it comes to managing. If you happen to fall into this bracket, get yourself a very good accountant who can help you manage your business.
You might think that understanding financial ratios doesn’t make any difference in the way you run your business, but, trust me, those who are good at managing businesses understand better the value of these figures.
In essence, ratios simplify financial statements; help in comparing companies of different sizes with each other; help in trend analysis, which involves comparing a single company over a period; and highlights important information in simple form quickly.
A user can judge a company by just looking at a few numbers instead of reading the whole financial statement.
Understand these ratios, as they can save you a lot of trouble in future. They can also help you identify risks in your business. As I always say, ignoring numbers is a recipe for failure.
Accountants may be very good at compiling these numbers, but as a business leader, you should understand what they mean and what you have to do in order to have favourable numbers and steer your company to safe waters.
Numbers do not lie. In whatever business that you are in, always play with numbers. Do not be fascinated by sales only, look at the broader picture of the business.
There are debtors ratios that look at how much the business is owed against the sales figure against the number of days in the year to show how long it would take for the business to receive the money it is owed by its customers.
The creditors ratios, on the other hand, shows how much the business owes its creditors, and it shows how long the business would pay its suppliers on current performance.
Business involves many dynamics.
One might be deceived by huge sales figures that do not take into account both creditors and debtors of the business. That is where ratios come in; the ratios will show you where major weaknesses are.
If you do not pay creditors, they will eventually pounce on your business.
For those aspiring to be entrepreneurs, you are duty bound to understand the basics of business. You have to understand financial statements and ratios. Knowing how a business is performing is crucial in business.
There are a lot of self proclaimed entrepreneurs in Zimbabwe who got rich by sheer luck and feel there are not obliged to follow seemingly academic fundamentals.
This is why many business fail.
I will repeat what I said earlier, if you are good at creating wealth but poor at managing it, please get a very good manager to manage your business.
It is time to see Zimbabweans that create businesses that last for centuries.
Financial ratios were designed to help you create such kind of businesses. Those who designed these ratios knew what they were doing.
In well-run companies these ratios are widely used and that is why their companies are successful.
If a weakness is noted from these figures, action should be taken to ensure the situation improves.
Businesses, especially small and medium businesses, should start to make use of them.
Taurai Changwa is an articled accountant and ACCA finalist. He is managing director of SAFIC Consultancy. He writes in his personal capacity and can be contacted at [email protected] or visit Facebook page SAFIC Consultancy and/or WhatsApp on 0772374784.
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