Using your financial statements to measure your business is one way to make sure that you and your business is moving in the right direction. In order to accomplish this you need a few things.
- Financial Statements (both accurate and timely)
- Consistency – In order to track the direction of the business, consistency is key. Knowing your ratios only once in a while will not show a true and accurate picture of your business and can lead to bad business decisions.
- Picking the right KPI’s (Key performance Indicators) or ratios. Some ratios are a better fit for some businesses more so than others.
The Debt to Equity Ratio is a good ratio to track the businesses financial leverage. It shows as a percent how well the business is at managing it’s debt to make a profit.
The higher the ratio the more reliant the business is on debt to turn a profit.
Example: Company A – Total Liabilities $80,000, Total Equity $120,000
$80,000 / $120,000 = .6666 or 66.66%
Company B – Total Liabilities $150,000, Total Equity $80,000
$150,000 / $80,000 = 1.875 or 187.5%
Company B is higher in debt and more reliant on external loans to make a profit. However, only showing this at one point in time does not show which direction the company is going in. Company A could have a lower ratio right now but shown over time could be increasing and Company B shown over time could be decreasing. Calculating this ratio over time shows the true nature of the ratio and shows if it is improving or not.
For more information do not hesitate to ask.