How these ratios can be easily obtained if you have a complete budget of your G/L
By Alan Hart, MBA
I have rarely, if ever, seen financial professionals generate standard Financial Ratios as part of the Budgeting and Forecasting process. While they are so valuable and helpful in analyzing past performance, based on actuals, wouldn’t it be interesting to see what those ratios will be during your budget plan and when changing assumptions in the budget?
In analyzing an actual balance sheet (i.e., using actual accounting numbers for a current or prior periods) financial professionals obtain these ratios by simply dividing two numbers that are presented on the balance sheet, to arrive at the desired ratio. While some of the ratios require the use of forecasted income statement items, or components of the Statement of Cash Flows, most use data from the forecasted balance sheet.
Some of the more common ratios are:
Current Ratio, Quick Ratio, Return on Equity, Return on Assets, Debt – Equity Ratio, Capitalization Ratio, Debt Ratio, as well as others.
There are several reasons why you use financial ratios. Your bank may require one or more ratios as part of certifying or re-certifying your eligibility for your line of credit, or as part of complying with loan covenants. Investors may look at certain ratios in order to determine whether or not to make an investment in the business. Some ratios, especially if tracked over time will give you an idea on the financial health of the organization and whether certain areas are improving or deteriorating.
Similar to analyzing the current health of the company using financial ratios obtained from actual accounting data, you can perform the same analysis using forecasted data if you can generate a forecasted Balance Sheet and a Statement of Cash Flows, in addition to the Standard Income Statement. You can even track certain ratios in different periods throughout your budget plan to see how they change over time. This is a powerful tool that can be utilized if you can generate an accurate forecasted balance sheet, constructed from your data input, assumptions, and chosen business rules. The Statement of Cash Flows is usually derived from the other two statements and automatically presented by the software.
As you likely have experienced, using traditional methods, such as spreadsheets, to build your annual budget and periodic forecasts, or other budgeting tools that rely on entering formulas and linking various worksheets, cannot realistically provide a forecasted balance sheet, at least not one that can be considered accurate enough to rely on. In reality, financial managers do not get visibility to the forecasted balance sheet information and the useful financial ratios that can be obtained from it.
As you begin to realize that a spreadsheet is not the right tool to forecast your balance sheet and obtain meaningful forecasted Financial Ratios, look for a purpose built application that allows a detailed and accurate forecast of your entire chart of account, as this will provide you with the needed Income Statement, Balance Sheet, and Statement of Cash Flows from which any financial ratio can be obtained, in any future period of your budget plan.
To me, this is a powerful use of my budget plan with intelligent insight into some of the most important financial data that should be included in every budget plan or forecast.
Why not add forecasted Financial Ratios to the repertoire of tools that you use to monitor the financial health of your business?