Financial Ratio Analysis

Financial ratio analysis is a useful technique to measure, compare, and evaluate the financial condition and performance of a customer. Ratio analysis enables a credit manager to spot trends in a customer's financial performance, and to compare its performance and financial condition with the average performance of similar businesses in the same industry. Balance sheet ratios measure liquidity and solvency (a business's ability to pay its bills as they come due) and leverage (the extent to which the business is dependent on creditors). Financial ratio analysis is used by credit professionals to answer these questions about customers:

• Is the business profitable?
  
• Can the business pay its bills on time?
  
• How is the business financed?
  
• How does the company financial performance this year compare to last year?
  
• How does the customer's performance compare with its competitors?
  
• How does the customer's performance compare to the industry norms?
  

Financial ratio analysis is a useful tool for determining a customer's overall financial condition. Industry-wide financial ratios are published by a variety of sources, including Dun & Bradstreet. Financial ratios are useful for making quick comparisons. Banks and trade creditors use financial ratio analysis to help them decide whether a business is a good credit risk or not.

See Financial Ratios.

Source: "Credit and Collection Manager's Manual" edited by Michael Dennis and Steven Kozack.