Financial Ratios for Entrepreneurs

# Financial Ratios for Entrepreneurs

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## Financial Ratios for Entrepreneurs

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1. Dirty little start-up Secret #14 Understanding financial ratios

4. WHY RATIOS HELP YOU COMPARE you know, like… how much money do I have in the bank today?

5. WHY RATIOS HELP YOU COMPARE you know, like… how much money do I have in the bank today? what are my operating expenses each month?

6. WHY RATIOS HELP YOU COMPARE you know, like… how much money do I have in the bank today? what are my operating expenses each month? how much cash can I expect to come in next week?

7. WHY RATIOS HELP YOU COMPARE but, while critical to the day-to-day operations of a business, absolute numbers are not as useful when it comes to strategy, where we are concerned with trends over time & operating efficiency

8. WHY RATIOS HELP YOU COMPARE let’s look at revenue by month as an example what does that absolute number tell you?

10. WHY RATIOS HELP YOU COMPARE but it does not tell you if that is…‘good’

12. WHY RATIOS HELP YOU COMPARE but let’s look at a concrete example

17. WHY RATIOS HELP YOU COMPARE but, can you see the problem?

19. WHY RATIOS HELP YOU COMPARE you can see this clear as day if you consider the most basic Ratio: Profit Margin

20. WHY RATIOS HELP YOU COMPARE profit margin is calculated as: net profit / sales it tells you how much money you make for every \$1 in sales

21. WHY RATIOS HELP YOU COMPARE now look again oh dear. margin is shrinking quickly!

22. WHY RATIOS HELP YOU COMPARE where you were making 70 cents per dollar of revenue in Q1, by Q5 you’re only making .37 cents so you’re selling more, but making less!

25. WHY RATIOS HELP YOU COMPARE we can check out the Sales Growth Ratio which is calculated as: (current period sales – previous period sales) /previous period sales

26. WHY RATIOS HELP YOU COMPARE hmmmm, despite a margin crisis, sales growth is actually improving over time kudos to your sales team

27. WHY RATIOS HELP YOU COMPARE so if it is not revenue that is pulling down your profitability, it must be cost

28. WHY RATIOS HELP YOU COMPARE let’s look at the Operating Expense Ratio which is calculated as: operating expenses / revenue

29. WHY RATIOS HELP YOU COMPARE a-ha. something is stinky! your costs are growing out of control

30. WHY RATIOS HELP YOU COMPARE do we need to fire the plant manager? are we somehow exposed to some raw materials cost fluctuations?

31. WHY RATIOS HELP YOU COMPARE let’s break our cost down into 3 categories (supply, manufacturing, distribution) & compare each against total cost (i.e.: supply cost / total cost)

32. WHY RATIOS HELP YOU COMPARE uh…were we too quick to congratulate sales?

33. WHY RATIOS HELP YOU COMPARE so while absolute numbers are important for day-to-day operations, ratios are critical for strategy because they allow you to look inwards & monitor / investigate the efficiency of your business over time it allows you to identify & solve problems

34. WHY RATIOS HELP YOU COMPARE but they’re useful for one other thing as well

35. WHY RATIOS HELP YOU COMPARE because ratios remove the absolute numbers, they can be used to compare your business against other businesses in your industry (even if those business are much larger or smaller) so that you know how well you fare relative to the competition or can spot interesting outliers

36. WHY RATIOS HELP YOU COMPARE why are we so good relatively? what is so unique about our business model and what does that mean for the future?

37. WHY RATIOS HELP YOU COMPARE you can actually make ratios out of any combination of absolute numbers depending on what aspect of your business model you want to investigate however, certain classic ratios have shown great value, and your management team should be monitoring these monthly

38. WHY RATIOS HELP YOU COMPARE please ensure that your CFO is producing these for your monthly management meetings and that you are reviewing them and asking questions i’ve dumped a bunch of classic ones in the appendix, but feel free to create your own depending on the nature of your business model and its unique problems

39. APPENDIX Liquidity Ratios! liquidity ratios tell you how much of your current assets can be used to meet short-term creditor claims

40. APPENDIX Activity Ratios! how efficient is a firm at using its assets to generate revenue

41. APPENDIX Leverage Ratios! what % of a firm’s assets are financed with creditor dollars (how much is owned by bank vs shareholders)

42. APPENDIX Profitability Ratios! how well are we doing

43. APPENDIX Market Ratios! used to compare firms in a similar industry