Multi-Unit Franchisee Magazine Issue I, 2014 | Page 90

Finance By Steve LeFever

Ratios Rule!
But do you know which ones to watch?

I

n earlier articles, I have discussed
your two key yardsticks of financial
performance: the balance sheet and
the income statement. Taken together,
they represent as complete a financial picture of your company as it’s possible to get.
Now, it’s a common practice (and a
sensible one) for businesses to have at least
two sets of financial statements (or maybe
three): one for the IRS (with the tax rules
and regulations making net profit look as
small as possible); one for your banker (adjusted to present the most glowing picture
of the business); and one for yourself. But
remember you can’t fool all of the people all
of the time. And the worst possible person
to fool is yourself. You need clear, concise,
decision-relevant information.
Incidentally, two or three sets of stateFINANCIAL RATIOS

ments does not imply two or three sets of
books (the general journal and the general
ledger, which report all financial events
that occur in the business). Having more
than one set of books implies falsifying
financial transactions, and that’s a good
way to go straight to jail, courtesy of the
IRS. On the other hand, a company’s financial statements put the information
from the books into a format influenced
by the purpose for which the statements
are being developed.
With that in mind, let’s take your
financial information and develop a set
of measurements that will allow you to
monitor both your current position and
your progress. We will do this through
the development of a series of financial
relationships, or ratios. Remember, a
HOW DERIVED

ratio is nothing more than one number
in relation to another. However, ratios
have the very practical property of reducing a relationship to one number,
no matter the size of the two numbers
involved. (For example, the ratio of 2:1
can be derived from 20 divided by 10,
200 divided by 100, or 200,000 divided
by 100,000.) The ratio doesn’t care about
the absolute size, only the relationship of
the numbers. And it’s this relationship
we will use to measure and manage your
financial effectiveness.
Clearly the question arises as to which
relationships to measure. There are many
possibilities, and each financial analyst will
have their own preferences. I have chosen
to use the K.I.S.S. (Keep it Simple, Silly!)
approach; that is, enough to get the job
do