Leverage is the extent to which a business utilizes liabilities relative to equity funding, to finance its operations. The equity multiplier is the ratio of assets to equity and is used in the financial projections template as one indicator of leverage.
Efficiency is the ability of a business to use its asset base to generate revenue (and therefore profit). The asset turnover ratio is used in the financial projections template as one indicator of efficiency, and shows the amount of revenue generated by the business relative to the amount invested in assets.
The financial projections template includes the calculation of four key financial ratios which indicate the profitability, efficiency, leverage, and liquidity of the business. It is important to monitor the four ratios in order to ensure that they are in line with industry norms. Any variation in either the absolute value or the trend in the ratio should be analysed and explained before finalizing the business plan financial projections.
When developing financial projections for your business plan it is useful to monitor the financial ratios produced so that they can be compared with other available data. By making the comparisons it is possible to see whether your financial projections are in line with industry, competitor, and if available, historical data. If the financial ratio comparisons reveal unexplained variations then the assumptions in the plan need to be improved and fine tuned to bring the projections in line with expectations.
On its own the return on equity formula tells you very little about how the business managed to make the return. In order to do this a technique called DuPont analysis is applied to the return on equity formula, which basically involves separating out the various aspects of the business to show how they have an impact on the equity return.
The return on equity (ROE) is used to measure the percentage rate of return the owner of a business gets on their invested equity.
The return on equity measures the ability of a business operation to use its money to generate earnings. It is calculated by dividing the net income by the owners equity.
Inventory represents the total of raw materials, work in process, and finished goods that a business holds for the purpose of resale.
Inventory days is calculated using the inventory days formula and shows the average number of days sales a business is holding in stock.
The Excel inventory days calculator, available for download below, calculates the inventory days by entering details of cost of sales, number of days in the accounting period, and the inventory balance.