Sunday, 18 April 2010

Evaluate a business using ratios

Ratio analysis is a useful tool that is widely used to measure business performance.  There are various groups of people who need information about the performance of a business.

Business success can be defined as "the achievement of business objectives".  Measuring success will therefore depend on a business's objectives.  For most businesses this is profit.

The financial performance ratios facilitate performance measurement between and within businesses.  Note that such ratios are meaningless in isolation and should be assessed in relation to a comparator or benchmark, which could include:

  • the previous year
  • the budget
  • an internal division or department 
  • a competitor.
Care should be taken to compare like with like.  There will be natural differences in ratios according to the nature of a business, its size, its age and the industry within which it operates.  Additionally, the period of comparison should be considered.  Ratios will usually fluctuate in the short term and therefore a medium- to long-term comparison should be used.


Ratios do not provide answers to every question and their interpretation can be subjective.  They are a useful guideline to business performance but only a starting point for a full analysis.  They are generally calculated on historic accounting information, which may itself include assumptions and estimates.


A variety of information will present the best overall picture of a business, such as

  • other information included in a company's annual report (for public listed companies); 
  • the age and nature of a business; 
  • any recent changes in the business, such as new products or market; and 
  • any changes in the industry within which the business operates and the wider economy.


These include

  • market share, 
  • customer loyalty, 
  • productivity, 
  • quality, and 
  • investment in research and development.  
NFPMs should be used alongside financial performance measures to provide a balanced view of a business.

Know the uses and limitations of financial performance ratios.

Related posts:

Measuring Business Performance

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