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The foundation of financial analysis, planning and decision-making is financial statements that majorly consist of Balance Sheet and Profit and Loss Account. While the profit & loss account shows the operating activities of a business entity, the balance sheet depicts the value of the assets acquired and of liabilities as at a particular point in time.
But, the above yearly statements fail to disclose all of the necessary and relevant information. In order to obtain the material, significant and relevant information required for ascertaining the financial strengths and weaknesses of a business start-up, it is important to analyze the data depicted in the financial statements.
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A ratio refers to “the indicated quotient of two mathematical expressions and as the relationship between two or more things.” Here, financial performance ratios or accounting ratios represent a mathematical expression of the relationship between accounting figures stated in the financial statements, which are connected with each other in some logical manner.
The analysis of financial performance ratios is based on the ground that a single accounting figure by itself might not communicate any meaningful information to the users. However, when it is expressed relative to some other figure, it can definitely provide some significant information.
When it comes to the sustainable growth of a start-up enterprise, it becomes of utmost importance to understand the health of the business firm. Here, the financial performance ratios tell us how healthy and financially viable a start-up firm is.
A sought-after technique of analyzing the performance of a start-up business concern or other established enterprise is that of financial ratio analysis. It is construed as a tool of financial management and attains crucial significance. The feature which accentuates the application of financial ratio analysis is that it presents facts on a comparative basis and enables drawing of inferences regarding the overall performance of a business.
It must be noted that the analysis of financial performance ratios is not just comparing different figures from the balance sheet, income statement, and cash flow statement. It also comprises the comparison of the numbers against previous years, other companies, the industry, or even the economy in general for the ultimate purpose of financial analysis.
The main objective of financial performance ratios is that all stakeholders (owners, investors, lenders, employees, etc.) can draw valuable conclusions about the following:
Financial Statement analysis with the aid of financial performance ratios is useful to various stakeholders to obtain the desired information about the start-up or other business entity. For instance,
The sources of information for financial statement analysis are:
There are four major categories of financial performance ratios which are as under:
Liquidity or short-term solvency is concerned with the ability of the start-up or other established entity to pay its short-term liabilities. The inability to pay-off short-term liabilities influences its credibility as well as its credit rating. Also, continuous default on the part of the enterprise leads to the situation of commercial bankruptcy, which may eventually cause its sickness and dissolution. Short-term lenders and business creditors are very interested in knowing the state of liquidity of the business because of their financial stake. Some of the important financial performance ratios used to assess the liquidity position of start-ups and other businesses include:
Ratios and How are they calculated?
is one of the most common measures of short-term liquidity. It answers the
question that whether your business has adequate current assets to satisfy the
payment schedule of its current debts with a margin of safety for possible
Quick Assets =
Current Assets − Inventories − Prepaid expenses
ratio is a much more conservative measure of short-term liquidity than the
current ratio. As quick assets comprise only cash and near-cash assets, this
ratio indicates the start-up’s ability to instantly use its near-cash assets to
pay down its current liabilities as and when they fall due.
Interpretation: It acts more as a measure of cash flow
than a ratio. The outcome of this calculation must be a positive number.
Bankers often look at ‘Net Working Capital’ over time to determine a company’s
capability to face financial crises and loans are often tied to minimum working
The leverage ratios are referred to as those financial performance ratios that measure the long-term stability and capital structure of the start-up firm or other business entities. Such ratios indicate the mix of funds provided by owners and outside lenders and assure the lenders of the long-term funds in respect of:
These ratios offer an insight into the financing techniques adopted by a start-up business, and, as a consequence, focus on the long-term solvency position. Some of the important financial performance ratios used to assess the long-term solvency position of start-ups and other mature businesses include:
Leverage Ratios and How are they calculated?
depicts the proportion of owners’ funds to the total capital fund invested in
the start-up or other business. It is believed that the higher the proportion
of shareholders’ fund, the lower is the degree of risk.
is used to analyze the long-term solvency of a business firm. A high debt to
equity ratio means less protection for creditors, and a low ratio, on the other
hand, signifies a wider safety cushion. This ratio is very often referred to in
capital structure decisions and is also used by lenders as it shows relative
weights of debt and equity.
equity = Equity and preference share capital + post accumulated profits (excluding
fictitious assets etc.)
addition to the debt-equity ratio, many a time capital gearing ratio is also
computed to showcase the proportion of fixed interest (dividend) bearing
capital to funds belonging to equity shareholders or net worth.
It shows the firm’s
ability to service the fixed liabilities, i.e., by establishing a relationship
between fixed claims and what is normally available out of which such claims
need to be paid. This ratio shows the extent to which EBIT may fall without
causing any embarrassment to the entity regarding the payment of fixed interest
Activity or turnover ratios are those parameters which are employed to evaluate the efficiency with which the business firm or a start-up manages and utilizes its assets. These are often also called as ‘Asset management ratios’. These ratios normally indicate the frequency of sales with respect to its assets. Such assets may be capital assets or working capital or average inventory. Some of the important financial performance ratios used to assess the degree of efficiency in the management and utilization of assets of start-ups and other businesses include:
Ratios and How are they calculated?
highlights the firm’s ability of generating sales/ Cost of Goods Sold per rupee
of long term investment. The higher the ratio, the more efficient is the utilization
of owner’s and long-term creditors’ funds. Net Assets include Net Fixed Assets
and Net Current Assets (Current Assets – Current Liabilities).
ratio establishes the relationship between the cost of goods sold during the
year and average inventory held during the year. It measures the efficiency
with which a start-up firm utilizes or manages its inventory. It shows how fast
inventory is used or sold. A high ratio is preferred from the view point of
liquidity and vice versa. A low ratio means that inventory is not used/ sold
and remains in the warehouse for a long time.
Interpretation: The speed with which accounts receivables
are collected impacts the liquidity position of the business firm. This ratio
throws light on the collection and credit policies of the entity. It captures
the efficiency with which management is managing its accounts receivables.
Interpretation: This ratio shows the velocity of payables
payment by the business enterprise. A low creditor’s turnover ratio showcases
liberal credit terms granted by suppliers, whereas a high ratio shows that
creditors’ accounts are settled rapidly.
The profitability ratios capture the profitability or the operational efficiency of the start-up firm or other mature business enterprise. These ratios reflect the final results of business operations, and are; therefore, some of the most closely watched and widely quoted ratios. The business management attempts to maximize these ratios in order to maximize firm value. The business results may be assessed in terms of its earnings with reference to a given level of assets or sales or owner’s interest, etc. Some of the important financial performance ratios used to assess the degree of profitability of start-ups and other businesses include:
Ratios and How are they calculated?
ratio envisages the relationship between net profit and sales of the start-up
entity. It identifies the proportion of revenue that makes its way into
profits. A high net profit ratio shall assure positive returns of the
Interpretation: ROI is the most significant profitability
ratio, which depicts the percentage of an overall return on funds invested in
the start-up business by its owners. It measures the overall return of the
business on investment/ equity funds/capital employed/ assets.
Interpretation: It is just another variation of ROI. ROCE
must always be higher than the rate at which the enterprise borrows. Capital
employed implies nothing but Net worth plus Debt. It tells the owners whether
or not all the effort put into the business has been worthwhile.
denotes the overall profit derived for each share in existence over a
particular period. The firm’s profitability from the point of view of ordinary
shareholders can be appraised in terms of earnings on per share basis.
At any point in time,
the P/E ratio is a parameter of how highly the market accords value to a
business. It indicates the expectations of equity investors about the earnings
of the entity. It relates earnings to market price and is usually considered as
a holistic measure of the growth potential of an investment, risk
characteristics, shareholders orientation, corporate image and degree of
Financial performance ratios are relevant in assessing the performance of a start-up firm or other mature entity in respect of the following aspects:
No business can succeed without proper planning and budgeting. Financial analysis through ratios is a step towards evaluating the overall business performance. We at Enterslice, have a team of expert financial analysts who can help you assess the business performance of your organisation to assist you in long-term growth planning.
Also, Read: How to Take Care of Financial Health of Your Startup?.
A CA together with MBA (Fin) and M Com, she relishes taking interest in insightful writing in the domain of taxation and finance. She has gained experience as a full-time author and has also served an accounting role in industry.
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