Ratio Analysis allows for only financial analysis of business performance. It primarily, and only, looks at quantitative factors – the numbers. However, in order to ensure that business managers have the complete picture of a firm, considering other qualitative factors is a must-to-do job.
You can find out more about the quantitative factors in How to Compare Business Performance Using Ratio Analysis? Below is just a brief summary:
A. Quantitative factors to judge the firm’s performance
Quantitative factors that help business managers to assess a company’s financial performance include sales volume, cost reductions and profitability. To judge the business using financial data, the following two methods are used:
- Historical comparisons – TRENDS. The same ratios should be compared year on year to identify any trends. And reasons behind those trends. This can help to determine any improvement or deterioration in the firm’s financial performance.
- Inter-firm comparisons – RANKS. Ratios should also be compared with ratios of competitors to assess the relative performance of the business using ranks. A firm’s Ratio Analysis may reveal that the business is doing better than its rivals (is outperforming its competitors) or worse (is being outperformed by its competitors)).
Two other quantitative analysis that can be used to evaluate the business performance include Cash Flow and Investment Appraisal.
B. Qualitative factors to judge the firm’s performance
Qualitative factors that help business managers to assess a company’s financial performance, include:
- Business aims and business objectives. Companies focused on maximizing profit, for-profit commercial organizations , will have much different business aims and business objectives from non-profit social organizations such as Non-Governmental Organizations (NGO) and Charities. Prominent social stance might be very difficult to measure purely using numbers.
- Performance of the management team. This includes effective management of all four business functions and scarce resources. In addition, while being responsible for effective management of profitability, liquidity, efficiency and long-term debt which can be measured, predicting future impact on the business of those ratios may not be so obvious. Setting and achieving long-term strategic goals also belongs to the responsibilities of the managers.
- Product quality. This refers to determining how well a good or service satisfies customers’ needs and wants as well as serves its purpose. The feedback from the customers will most likely be in the form of comments, statements and opinions, hence very difficult to be presented as numbers.
- Customer loyalty. Having an ongoing emotional relationship based on trust with the customers is not included in any of the ratios. But, how willing a customer is to engage with and repeatedly purchase from the business versus buying from other firms, may somehow be counted though.
- Relationship with suppliers. Positive relationships are built over time upon successful experiences and positive feelings. A strong relationship with suppliers will help to navigate better when disagreements and problems emerge. And, when it comes to feelings, even the best numbers may not matter after all.
- The state of the economy. The businesses will usually do better when the economy is in the state of boom and peak, while the performance will be much worse during the state of recession and slump. This will most likely happen regardless of individual performance of an individual business.
- Other external factors. This may include a firm’s commitment towards setting ethical objectives towards all members of the society and being environmentally friendly, e.g. reducing air pollution, minimizing excessive packaging, waste control and maintaining stable employment for the local community.
- Luck. The element of luck much needed in running a business organization seems to be quite impossible to measure quantitatively.
Whilst Ratio Analysis helps with management decision-making using numbers, it is important to also consider other qualitative factors when measuring the performance of any business organization. It is because in order to properly and comprehensively assess the business performance, business stakeholders should look at the complete picture of a firm.
