Using financial ratios in business helps you understand how your business is performing beyond the headline numbers. A profit figure, cash balance or sales total can tell you something, but ratios help you compare, question and interpret those numbers. They can show whether profit is strong, cash flow is under pressure, assets are being used well, or risk is increasing.

This episode is for business owners, managers, charities, arts organisations and social enterprises who want to get more meaning from their financial statements. We look at what ratios are, where the information comes from, the four main areas of ratio analysis, and the limits of using ratios on their own.

About this episode

Numbers are not just there to sit in a report. Every sale, purchase, wage payment, freelancer cost, success, problem and business decision eventually feeds into your financial statements.

Financial ratios help us take those figures and turn them into something more useful. Instead of looking at isolated numbers, we compare one number with another to understand what is really happening.

In this episode, we explain ratio analysis in plain English. We look at the source documents behind the numbers, the main areas that financial people examine, and why ratios need context before we make decisions from them.

Why financial ratios matter

Financial ratios matter because they help us make sense of business performance. A number on its own can be useful, but it does not always tell the full story.

For example, a profit figure of £50,000 may sound good. However, that number becomes more useful when we compare it with sales. If sales are £200,000, then profit is 25% of sales. That percentage gives us a clearer way to understand performance.

Ratios also help us compare performance over time. We can look at this year against last year, compare different parts of the business, or benchmark against other organisations where suitable information is available.

For a wider foundation, our episode on understanding your financial statements explains how the profit and loss, balance sheet and cash flow statement work together.

Key points from this episode

What is a financial ratio?

A ratio is a relationship between two or more numbers. In business, financial ratios help us compare figures so we can understand performance more clearly.

Ratios can be shown as percentages, fractions or simple numbers. The format matters less than the insight we get from the comparison.

For example, if your business makes £50,000 profit from £200,000 of sales, that tells us profit is 25% of sales. That is more useful than looking at the profit figure alone.

Where the information comes from

Financial ratios usually come from the main financial statements. These are the profit and loss account, the balance sheet and the cash flow statement.

The profit and loss account shows sales, expenses and profit over a period of time. It helps us understand whether the business made a profit or loss.

The balance sheet is a snapshot at a point in time. It shows what the business owns, known as assets, and what it owes, known as liabilities.

The cash flow statement shows money moving in and out of the business. It connects the dots between trading activity, spending, cash in the bank and business survival.

Understanding the language in these reports is important. Our guide to financial terminology for business owners explains terms such as profit, operating costs, assets and balance sheets in more detail.

Profitability ratios

Profitability ratios help us understand whether the business is making enough profit from its activity.

Gross profit margin is one common example. It compares gross profit with sales and shows how much is left after direct costs are taken away.

Net profit or operating profit margin looks further down the profit and loss account. It shows what remains after overheads and support costs have also been considered.

These ratios matter because profit helps build reserves, reward effort, support the team and create a more sustainable business.

Efficiency ratios

Efficiency ratios look at how well the business uses its resources.

This is not about judging how hard one person works. It is about asking whether the assets, stock, people, space and systems in the business are being used well to create value.

For example, a retailer or manufacturer may look at how quickly stock turns into sales. Another business may look at profit per staff member, profit per square metre, or sales generated from available assets.

Liquidity ratios

Liquidity means access to cash. A business may appear profitable but still struggle if cash is tied up in stock, customer accounts or slow payments.

Liquidity ratios help us look at whether the business has enough cash or near-cash resources to meet its commitments.

One useful measure is debtor days, also called receivable days. This looks at how long customers take to pay after receiving an invoice. The longer that figure grows, the more pressure it can put on cash flow.

Cash matters because without it, even a profitable business can face serious problems.

Risk and return ratios

Risk and return ratios look at the reward generated from the risk taken in the business.

Every business carries risk. The important question is whether the return is strong enough for the level of risk involved.

This area can be useful for business owners, investors and decision-makers who want to understand whether the business is generating enough value from the money, time and resources invested.

Why ratios need context

Ratios can be powerful, but they are not perfect. We should not use them in isolation.

Good ratio analysis needs context. We need to look at trends, compare like with like, and consider whether the financial statements are reliable.

Technology and accounting software can produce many ratios quickly. However, more numbers do not automatically mean better insight. The real value comes from choosing the right ratios, asking better questions and understanding what the figures are telling us.

FAQs about using financial ratios in business

What are financial ratios in business?

Financial ratios compare two or more numbers from your business accounts. They help you understand performance, profit, cash flow, efficiency and risk more clearly.

Why are financial ratios useful?

Financial ratios make large numbers easier to understand. They help you compare performance over time, spot trends and ask better questions about your business.

What financial statements are used for ratio analysis?

Ratio analysis usually uses figures from the profit and loss account, balance sheet and cash flow statement.

Should financial ratios be used on their own?

No. Financial ratios should be used with other information, including trends, business context, reliable records and your own knowledge of what is happening in the business.

Episode Timecodes

00:00 – Why business owners need to understand performance
00:27 – Source documents and key areas of ratio analysis
01:18 – Mahmood’s background and purpose of the episode
01:48 – How business activity feeds into the numbers
02:21 – What a ratio means
03:00 – Profit and sales ratio example
04:16 – Why ratios help make numbers more manageable
04:52 – The three main financial statements
05:40 – Profit and loss account explained
05:40 – Balance sheet explained
06:51 – Cash flow statement explained
07:30 – Four key areas of financial ratio analysis
08:02 – Profitability ratios
08:41 – Efficiency ratios
09:08 – Liquidity and cash availability
09:48 – Risk and return
10:21 – Gross margin example
12:09 – Using assets efficiently
12:49 – Debtor days and cash flow pressure
14:26 – Limitations of financial ratios
15:01 – Final recap

Related episodes

Key takeaway

Using financial ratios in business helps us turn raw numbers into useful insight. Ratios can show how profitable the business is, how well resources are being used, how strong cash flow looks, and whether risk and return are balanced.

The key is not to calculate ratios for the sake of it. Use them to spot trends, ask better questions and make stronger decisions. Ratios are most useful when we combine them with reliable financial statements, business context and practical judgement.

Plan it, Do it, Profit.

“Financial ratios help us turn raw numbers into insight, so we can understand performance and make better business decisions.”

Further Support

The I Hate Numbers podcast helps business owners understand accounting, tax, finance, profit, cash flow, and business planning in a practical way. We simplify financial topics so you can make better decisions and feel more confident with your numbers.

You can also watch more practical finance and business support on the I Hate Numbers YouTube channel, or listen and follow on Apple Podcasts.

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Using Financial Ratios in Business: Measure Profit, Cash Flow and Performance