In addition to examining the detailed information in these financial statements, calculating a few simple financial ratios can help you to assess how well a business is performing and provide early indications of financial problems:

Ratios can be used to set targets, and to provide early warning signs of any financial issues that need attention.

Ratios can be compared against other businesses operating in a similar sector, giving an idea of relative performance.

Banks use financial ratios as part of their computerised credit-scoring system, to determine whether to lend money to a business. The terms of a bank loan may require a business to repay the loan immediately if its ratios indicate that there is a financial problem.

This factsheet introduces the key financial ratios and explains how to calculate them. It also suggests typical values for a healthy business. However these suggestions are only intended as a starting point, since typical values vary between sectors and there may also be some seasonal variation in financial ratios.

Some familiarity with the three key financial statements mentioned above will make it easier to understand this factsheet. See our guides; Understanding Profit and Loss Accounts, Understanding Balance Sheets, and How to Forecast Cash Flow – for more information.