Financial Ratios are important in so many ways as it is through these that you can make sense of the financial position. There are different types of ratios that give you different perspectives with some resources having as much as 5 or 6 different types. In this guide, we will be exploring 4 types of ratio categories. However, two great resources to learn more about ratios and what ones you might need are 4 types of financial ratios to assess your business performance | BDC.ca/ Financial Ratios – Complete List and Guide to All Financial Ratios (corporatefinanceinstitute.com). In addition, in the Financial Assistance portion of the guide, we also have an outline of key ratios to keep in mind.

Profitability Ratios

These ratios are typically used to analyze the how profitable your organization is. That could be as a ratio of how much your assets are generating revenue for you in the return on assets ratio or your equity stake in a return on equity. You can also determine the amount of profit for every dollar of revenue by using the Net profit margin ratio.

Liquidity

Liquidity is all about your current portion of your financials and your ability to pay back your debts or current portion of your debt and ensure that you can stay afloat for the year. In this context the term current means less than one year. We go into more detail in the Financing Help guide on these terms.

If you are noticing that you have liquidity issues, they can be solvable depending on your situation, it can mostly mean an adjustment in your spending and trying to find efficiencies in your cash management, which the next set of ratios can help isolate and help lead you towards finding a solution.

Activity Ratios/Efficiency

As mentioned in the previous portion, these ratios are all about how efficient you are operating at, how quickly you are turning over your revenue, and collecting on your accounts receivables (A/R). If you notice that you are running short on cash, are you maybe holding too much of it in your inventory or, are you not collecting it quickly enough?

Solvency/Leverage Ratios

If liquidity is all about the current portion, then solvency ratios are about the big picture. These ratios compare if you currently in a position to cover your debts. The most common is the Debt to Assets ratio, which is where you take your total liabilities and divide it by the total Assets. Which then gives you a relative understanding of the healthy of your businesses. Another one is the Debt to Equity, which shows how your business is being financed, is predominantly debt financed (a higher ratio) or is more funded by investors (lower ratios).

Solvencies ratios are the most influential ratios as they tell the long-term health of the business, and the higher they are leverage/the more they are insolvent, means the less ability they will have to be able to repay their debts, and more likely they are to file for bankruptcy. Whereas if you are having issues with Liquidity, Issues with being solvent, are harder to adjust and find solutions to. As the more insolvent you become that harder it is to raise capital for your business to grow and expand.” To “Solvencies ratios are the most influential ratios as they tell the long-term health of the business. The more the business is leveraged the more it is insolvent. This means the business will have less to cover its debts. Compared to liquidity issues, solvency issues are much more difficult to find solutions to.

Debt Service Coverage Ratio

The Debt Service Coverage Ratio is a special solvency ratio that calculates your ability to repay your debts known as servicing the debt. This is one of the favourite ratios used by investors and bankers to ensure that you have the capability to repay their investment. A ratio that is more than 1.25 is ideal, considering you include the amount you are potentially borrowing in the calculations. However, the higher the better, as that indicates that for every dollar of debt obligations you have, you are generating over $1.25 of operating income.

It is calculated taking your EBITDA and dividing it by your current debt obligations. EBITDA is your Earnings Before Interest, Taxes Depreciation and Amortization. It is calculated, as you may assume, by taking your profit prior to deducting any interest and taxes, and then adding back in the depreciation and amortization expenses. Your current portion of long-term debt is the total interest and principal payments you will have to make over the next year.