If you are about to approach a bank or an investor who wants to invest in your business, you need to show him that you have considered the big picture. Your business idea might be great but what is more important is the base in which they will make their decision to invest in your business.
Financial ratios are useful in this case. They are used to come up with mathematical interpretations of the financial outlook. The relationships between these financial ratios do not just help impress your investors, they also help the internal management understand how well the business is performing and the areas where it needs improvement. Simply, Financial ratios are a vital tool for understanding the strengths and weaknesses of a business.
There are a number of Financial Ratios used in business analysis and they are often categorised as below.
- Profitability ratios
- Liquidity ratios
- Efficiency ratios
- Working capital ratios
- Asset usage ratios
However, if you study ratios more, you would find different categorisations. Hence, if you are not willing to dig deep into the subject, you might as well stop at having an understanding on some key ratios that are common and vital for any business. These ratios are likely to be in an acceptable range, if you have a steady growth and if the debts are kept minimum. If you have so many debts and your expenses are higher than your income, then these won’t be in an acceptable range.
As financial ratios are raw computations of your business performances, it is always good to maintain an acceptable range when reaching out to investors and banks. If the ratios are not in an acceptable range, banks would offer the loan at a higher interest or they might not offer it at all.
Some investors, however, tend to take the risk and invest in the business even if the ratios are not in an acceptable range. They tend to be convinced by the vision and the capability of the owner or they can be convinced by the long-term potential of the product. At the same time, some investors would not invest in your business sometimes even if the ratios are maintained well, as some of them tend to have their own criteria regarding business valuation. You should understand that Ratios are not a silver bullet, as investment decisions depend on many other factors as well. However, it is wise to be regularly checking your ratios and maintaining healthy levels.