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Business Relationships ( The Numbers )

Guest post by: Stan Prokop

Article Overview: The article provides insights into the value of business owners and financial managers understand certain key relationships of numbers in their financial statements

Business Relationships ( The Numbers )

As most business owners and financial managers know there is a significant failure rate in businesses that are fairly new. Statistics might vary, but everyone would agree that any business failure is a disappointment for all concerned, the entrepreneur, and his lenders, suppliers, etc.

It is generally agreed upon that businesses fail due to mismanagement or poor financing.

We will take a look at how business owners and their managers fair to recognize operating difficulties.

Proper control in a business revolves around good information. In business, whether we like it or not, it's about the numbers. The business owner must be familiar with what's happening. So how does he or she do that? Well, let's say we have our 'numbers '. Then what? The answer is we need to look into and beyond the numbers. That is the essence of our message - what are the ' relationships' between some of those very important numbers such as sales, gross margins, expenses, income, etc.

The analysis and understanding of those 'relationships' in the numbers is called ratio analysis. It can take very rudimentary forms, and it can also, by the owner's choice, be very sophisticated.

Where do the numbers come from - the answer is of course the balance sheet and income statement. (To some degree the cash flow statement also)

Owners and managers who are 'non- financial' in their backgrounds know there is 'a lot 'of info in those numbers! The balance sheet provides the true values of the assets and liabilities of the business; the income statement shows sales, profits and expenses. Typically the owner is provided with comparative numbers on a month to month or year over year basis.

So what else does the owner need then? Remember also that is suppliers and lenders and others who have a vested interest in the business that want to see those numbers also.

The key to our message of number 'relationships' - those 'ratios 'is comparison. When numbers are compared they have the ability to convey a lot more to the business owner.

Financial ratios are essentially one number divided by another number. There are hundreds of possibilities for the business owner to look at ratios which are relevant to their business. The purpose of every ratio is to find some meaning in the numbers. Lenders and credit people thrive on ratios.

For business owners there are essentially four groups of ratios:

Liquidity

Leverage

Profitability

Operating

Business owners, especially non financial in background often don't want to spend too much time on all these ratios! However effective and regular use of ratios can allow business to compete and change more effectively.

What can ratios tell us? As we have said, there are hundreds of possible ratios to be analyzed, and they can answer the most basic of questions:

How liquid are we - can we pay out bills

What types of returns are we making on our investments?

Are out inventories turning fast enough for our industry

Let's look at only one ratio as an example - We will use the 'SALES PER EMPLOYEE 'ratio. It is calculated by taking Net Sales and simply dividing by total employees - Naturally if the answer, in comparison is that our sales per employee are going down we may have issue to investigate. Again, that's one example of many hundred.

In summary, ratios, or the relationships of the numbers in business help business owners to better manage and understand their company. That's important in today's competitive environments.

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Article Tags: business failure, financial ratios



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