There are 100’s of ratios used to analyze financial statements if you are an investor. Some of these ratios are specific to industries and business models, i.e. manufacturing vs. service. Regardless, if you are the owner or a partner in an entity, there are three primary metrics that measure the financial health of your company, that should be reviewed periodically –
Profit – Funds available after total expenses are deducted from total revenues. The basis from which taxes are calculated. Pre-tax profits can be calculated monthly, quarterly, annually. This value is ideal to plan annually.
Return on Investments (ROI) – Ratio of Income generated over dollars invested in a process or product financed, to stimulate the growth of the company. ROI is usually tracked for three to five years. This statistic should be used to ensure that financial resources are being allocated to growth opportunities with the highest returns.
Free Cash Flow (FCF) – Funds available after paying expenses, adjusted for non-cash items, minus capital expenditures to maintain the firm’s current productive capacity, i.e. the amount available for distributions or future growth prospects. FCF is an annual measure.
A company should only allocate cash to the most profitable uses, with the highest return on investment, which will provide potential distributable benefits to its investors, within the shortest amount of time.
The preferable way to present this data is via a Scorecard that highlights Key Performance Indicators (KPI’s) that the company deems appropriate to gauge success at achieving strategic goals. These reports are metric centric and show results over time. As a general rule, KPI’s provide information which gives the reader a quick glance of success from a financial, operational, and risk perspective. A successful scorecard will assist the company drive profitability, reduce costs and provide insight into risk.
What ratio do you use to track your success?