You can use accounting ratios to see how your company’s finances progress over time or to benchmark your company against others in your sector. They are a useful indicator of how healthy your company is financially and can be used as an early warning signal.

Looking at just one ratio alone is not very helpful. You need to compare it with other values for it to mean anything. Here are some tips to help you get the most out of accounting ratios:

• Select a limited number of key ratios covering at least four financial years;
• Don’t change the formula you use to calculate the ratios – otherwise your figures won’t be comparable;
• Take into account any particularities of your sector.

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There are different ways of analyzing your accounts, and the one or ones you use will depend on your goals, and the sector you are operating in and the market conditions. Here’s an overview of the main methods.

Trend analysis

The aim here is to get an overview of how your company is changing over time. Each line item is analyzed individually over a specific period to try and spot patterns. By looking at trends over a given period, it is possible to understand what happened in the past, analyze the present and have a better idea of what could happen in the future.

Structural analysis

This type of analysis aims to provide an overview of your company’s financial situation. It involves looking closely at the income statement, balance sheet and cash-flow statement and determining the weighting (as a %) of each item. Looking at each item on the income statement proportionally to turnover, for example, can help you to better understand the different margins (i.e., the commercial, operating and net margins).

Accounting ratios

A ratio shows the relationship between two amounts. The two amounts can come from the same statement (such as balance-sheet ratios) or be made up of items from different statements (such as profitability ratios). Ratios can be used to analyze financial profitability, economic profitability, leveraging, etc.

Benchmarking

It can be useful to compare your company’s position to that of your competitors or to a sector benchmark. It is common to benchmark turnover, earnings, profitability, cash flows, capital expenditure, and working capital needs.

Cash flow analysis

This type of analysis looks at the various factors that affect the company’s cash position over a given period, which is usually a financial year. This is done by drawing up a cash-flow statement, which brings together all the relevant information on the three types of activities within a company – operations, investing and financing.