Use Trend and Industry Analysis to Compare Your Financial Ratios

Financial Ratios are Best Used to Compare and Contrast Data

Financial ratios are one excellent way to analyze your financial position, but they mean nothing in isolation. Let's say you calculate your debt ratio and it is 50%. All this means is that 50% of your firm is financed with debt and 50% with equity. You don't know if that is good or bad.

If you have comparative data, then you can have some basis for comparison and can make a determination if your debt ratio is appropriate for your firm.

Trend Analysis

Presumably, you have other years of balance sheet data for your small business. It is very helpful if you calculate the financial ratios for several years (or quarters if you have that data) so you can track the trends in your ratio.

Industry Analysis

Just as important as trend analysis is industry analysis. It's very important, particularly in today's economic climate, to know what your industry is doing as compared to your company. For example, if your industries ratios are much different than your firms, you want to examine why and perhaps take action.

The problem is finding industry average ratios. They are out there, but they are rather expensive to gather. If you live near a college or university town, my best advice is to visit a university library where you can get a print copy of industry averages free. The books you are looking for are the Valuline Surveys and the Standard and Poor Industry Averages.

These volumes are also online at a cost.

You need to do both trend and industry analysis for every financial ratio you calculate to get a full picture for your firm.