If you like this presentation – show it...

Slide 0

Understanding financial ratios
Dirty little start-up Secret #14

Slide 1

WHY
RATIOS HELP YOU COMPARE
as a start-up founder, it is important to know the absolute numbers of your business

Slide 2

WHY
RATIOS HELP YOU COMPARE
you know, like…

Slide 3

WHY
RATIOS HELP YOU COMPARE
you know, like…
how much money do I have in the bank today?

Slide 4

WHY
RATIOS HELP YOU COMPARE
you know, like…
how much money do I have in the bank today?
what are my operating expenses each month?

Slide 5

WHY
RATIOS HELP YOU COMPARE
you know, like…
how much money do I have in the bank today?
what are my operating expenses each month?
how much cash can I expect to come in next week?

Slide 6

WHY
RATIOS HELP YOU COMPARE
but, while critical to the day-to-day operations of a business, absolute numbers are not as useful when it comes to strategy, where we are concerned with trends over time & operating efficiency

Slide 7

WHY
RATIOS HELP YOU COMPARE
let’s look at revenue by month as an example
what does that absolute number tell you?

Slide 8

WHY
RATIOS HELP YOU COMPARE
pretty much just that . what is your revenue

Slide 9

WHY
RATIOS HELP YOU COMPARE
but it does not tell you if that is…‘good’

Slide 10

WHY
RATIOS HELP YOU COMPARE
that’s where ratios come in

Slide 11

WHY
RATIOS HELP YOU COMPARE
but let’s look at a concrete example

Slide 12

WHY
RATIOS HELP YOU COMPARE
here is a hypothetical business that makes concrete for buildings

Slide 13

WHY
RATIOS HELP YOU COMPARE
you happy with that as a founder? do you understand your business?

Slide 14

WHY
RATIOS HELP YOU COMPARE
not really

Slide 15

WHY
RATIOS HELP YOU COMPARE
what if I add this bit of detail?
wow! what an amazing business right? look at that steadily increasing profit!

Slide 16

WHY
RATIOS HELP YOU COMPARE
but, can you see the problem?

Slide 17

WHY
RATIOS HELP YOU COMPARE
this business is making money now, but it cannot scale

Slide 18

WHY
RATIOS HELP YOU COMPARE
you can see this clear as day if you consider the most basic Ratio:
Profit Margin

Slide 19

WHY
RATIOS HELP YOU COMPARE
profit margin is calculated as:
net profit / sales
it tells you how much money you make for every $1 in sales

Slide 20

WHY
RATIOS HELP YOU COMPARE
now look again
oh dear. margin is shrinking quickly!

Slide 21

WHY
RATIOS HELP YOU COMPARE
where you were making 70 cents per dollar of revenue in Q1, by Q5 you’re only making .37 cents
so you’re selling more, but making less!

Slide 22

WHY
RATIOS HELP YOU COMPARE
why?!?

Slide 23

WHY
RATIOS HELP YOU COMPARE
why is your margin shrinking?
is it revenue?

Slide 24

WHY
RATIOS HELP YOU COMPARE
we can check out the Sales Growth Ratio which is calculated as:
(current period sales – previous period sales) / previous period sales

Slide 25

WHY
RATIOS HELP YOU COMPARE
hmmmm, despite a margin crisis, sales growth is actually improving over time
kudos to your sales team

Slide 26

WHY
RATIOS HELP YOU COMPARE
so if it is not revenue that is pulling down your profitability, it must be cost

Slide 27

WHY
RATIOS HELP YOU COMPARE
let’s look at the Operating Expense Ratio which is calculated as:
operating expenses / revenue

Slide 28

WHY
RATIOS HELP YOU COMPARE
a-ha. something is stinky!
your costs are growing out of control

Slide 29

WHY
RATIOS HELP YOU COMPARE
do we need to fire the plant manager?
are we somehow exposed to some raw materials cost fluctuations?

Slide 30

WHY
RATIOS HELP YOU COMPARE
let’s break our cost down into 3 categories (supply, manufacturing, distribution) & compare each against total cost
(i.e.: supply cost / total cost)

Slide 31

WHY
RATIOS HELP YOU COMPARE
uh…were we too quick to congratulate sales?

Slide 32

WHY
RATIOS HELP YOU COMPARE
so while absolute numbers are important for day-to-day operations, ratios are critical for strategy because they allow you to look inwards & monitor / investigate the efficiency of your business over time
it allows you to identify & solve problems

Slide 33

WHY
RATIOS HELP YOU COMPARE
but they’re useful for one other thing as well

Slide 34

WHY
RATIOS HELP YOU COMPARE
because ratios remove the absolute numbers, they can be used to compare your business against other businesses in your industry (even if those business are much larger or smaller) so that you know how well you fare relative to the competition or can spot interesting outliers

Slide 35

WHY
RATIOS HELP YOU COMPARE
why are we so good relatively? what is so unique about our business model and what does that mean for the future?

Slide 36

WHY
RATIOS HELP YOU COMPARE
you can actually make ratios out of any combination of absolute numbers depending on what aspect of your business model you want to investigate
however, certain classic ratios have shown great value, and your management team should be monitoring these monthly

Slide 37

WHY
RATIOS HELP YOU COMPARE
please ensure that your CFO is producing these for your monthly management meetings and that you are reviewing them and asking questions
i’ve dumped a bunch of classic ones in the appendix, but feel free to create your own depending on the nature of your business model and its unique problems

Slide 38

liquidity ratios tell you how much of your current assets can be used to meet short-term creditor claims
APPENDIX
Liquidity Ratios!

Slide 39

how efficient is a firm at using its assets to generate revenue
APPENDIX
Activity Ratios!

Slide 40

what % of a firm’s assets are financed with creditor dollars (how much is owned by bank vs shareholders)
APPENDIX
Leverage Ratios!

Slide 41

how well are we doing
APPENDIX
Profitability Ratios!

Slide 42

used to compare firms in a similar industry
APPENDIX
Market Ratios!

Slide 43

SHARE THIS DECK & FOLLOW ME
(please-oh-please-oh-please-oh-please)
stay up to date with my future slideshare posts
http://www.slideshare.net/selenasol/presentations
https://twitter.com/eric_tachibana
http://www.linkedin.com/pub/eric-tachibana/0/33/b53
Please note that all content & opinions expressed in this deck are my own and don’t necessarily represent the position of my current, or any previous, employers

Slide 44

CLICK HERE FOR MORE!!!!