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Divided We Stand

How important are financial ratios in a financial proposal?
May 1, 2000
URL: http://www.entrepreneur.com/article/26114

Q: Does our print and copy shop need financial ratios in our financing proposal?

A: Absolutely! However, ratios are even more important for everyday managing than for occasional financing. Our lives are full of ratios, such as miles per hour, batting averages and horsepower. Ratios are simple arithmetic--one number divided into another. In business, there are two large "families" of relationship ratios--financial and operating.

Compare your company's past performance to performance aggregates of similar companies (external analysis), or to your past or planned performance (internal analysis). Ratios highlight trends in your business. Historical ratios make performance forecasts credible.

Investors and lenders use ratios to measure your competence and company's financial efficiency. Financial ratios come from an in-come statement and balance sheet.

Consider some examples. From the income statement, one views net profit before taxes or sales commissions as a percent of net sales. From the balance sheet, we see fixed assets as a percent of total assets or total debt to owner's equity. From the two combined, one finds days sales in accounts receivable or days sales in inventory.

Operating ratios combine either financial data with performance data, or two elements of performance data. For example, maintenance expenses per hour of press operations or pages scrapped per pages copied are found.

Put ratios to the test of six questions: Is there a difference in my ratio against the external in-dustry average or my internal history? Is it a meaningful difference? Is it a good or bad difference? What caused it? Does the cause require that I take action? What action should I take?

The right ratios will give early warning and make sense to you and your employees. Get financial ratios monthly and operating ratios daily or weekly. Financial ratios are red flags. Operating ratios are screaming sirens!

Check with your trade association for aggregated industry ratios. Look for the Robert Morris Comparative Statement Studies on print shops.

George m. Dawson (gdawson@txdirect.net) is a small-business consultant and author of Borrowing to Build Your Business: Getting Your Banker to Say "Yes" (Upstart Publishing, $16.95, 800-235-8866). Send him your financing questions at bsumag@entrepreneur.com.