The purpose of all financial analysis is to determine the financial effects on a business based on current, past and possible future managerial business decisions. Since all aspects of a business are interrelated, it is imperative that accurate measurements be taken of its financial operations to determine future courses of actions in order to make the best possible financial decisions.

Essentially, financial ratios are compiled by taking numbers from a business's financial statements and converting them into meaningful relationships and indicators of the financial performance of the business. These ratios are expressed as either as a times multiple (x) or a percentage (%). Calculating financial ratios covering the current and past fiscal years or periods of a business and then comparing them against each other or comparable industry averages for the same time period will provide an insight into the business's financial condition and operational performance. Generally, financial ratios are categorized into five sections: liquidity, debt, profitability, cash flow and market measurability.

Financial ratios do have limitations in their application and are not meant to be used as definitive answers as to the understanding of the financial operations of the business. They are simply used to provide additional evidence in the determination of the results of financial decisions that have or are being made. Financial ratios also become more appropriate when calculated and tracked over time to ascertain trends in the business.

Examples of the calculation of these ratios together with their meanings can be found in most accounting text books in any library or by requesting this information from the accounting firm who handles the financial affairs of the business. Various computer software packages are available that will calculate financial ratios and provide written analysis given that the appropriate financial information is provided from the financial statements of the business.

However, a word of caution, an individual ratio calculation should be tempered by taking into account other ratio analyses which results in a more effective evaluation of the financial operations of the business. Similarity, using industry averages as a comparative tool can also lead to inappropriate assumptions, as these industry averages may be based in dissimilar accounting policies and practices. Therefore, it is imperative that calculation of these industry averages be fully understood before using them as a comparative tool.

Industry averages of various types businesses can be obtained for a fee from places like Statistics Canada, CCH Canadian Ltd., Dun & Bradstreet Canada, Standards and Poor's Corporation, etc.

The most important point is that every business must determine their own needs and obtain the best possible financial information so that their operations may be analyzed to whatever degree deemed appropriate

There are three parts to this guide:

1. Financing Options, which lists and defines various types of financing available to business;
2. Financing Terms, which is a list of common terms used by financial institutions; and
3. Key Ratios, an explanation of common .cfm that are used as guidelines at financial institutions to assess the state of your business.

Accounts Receivable Financing - obtaining a loan from a financial institution, factor or commercial finance company to finance day-to-day operation. The accounts receivable of the business are pledged as security on the loan.

Angels -private individuals with capital to invest in business enterprises.

Bridge financing - an interim loan made for a short period during which the borrower is arranging long-term financing.

Business Improvement Loans - government-guaranteed loans within specific limits to businesses engaged in designated lines of endeavour.

Equipment Financing - borrowing from a financial institution, finance or acceptance company to purchase machinery or equipment, and using that equipment as collateral.

Equipment Leasing - obtaining the use of machinery, vehicles or other equipment on a rental basis. This avoids the need to invest capital in equipment. Ownership rests in the hands of the financial institution or leasing company, while the business has the actual use of it.

Export Financing - in addition to the commercial banks, export financial assistance may also be accessed from other agencies, including the Canadian Commercial Corporation (CCC), the Canadian International Development Agency (CIDA), and the Export Development Canada (EDC).

Floor Financing - usually used by car dealers, agricultural dealers, as well as piano, furniture and large appliance dealers to finance their floor stock. The lender maintains legal ownership of the floor items while the retailer displays them for sale.

Factoring - selling trade accounts receivable on a non-recourse basis to a factoring company, which assumes responsibility for credit and collections. The amount advanced as a percentage of approved receivable will vary depending on the factoring company.

Inventory Financing - inventory is used in two ways: (1) to support a loan; or (2) to obtain additional credit to increase inventory. In the case of a manufacturer, a financial institution may take a debenture or security under Section 88 of the Bank Act. If the goods are kept in a public warehouse, the financial institution may make advances under Section 80 of the Bank Act. Other lenders advance funds to businesses against warehouse receipts or debenture security.

Junior Capital Pool - is an offering by an issuer, which has no significant assets and/or business, and has (1) no specific plan for the acquisition of any asset or business, or (2) a specific plan, but such plan is not at the stage of an enforceable agreement, for the acquisition of an asset or business. Accordingly, it is one in which the investor is invited to rely primarily on the issuer's promoters, directors and officers.

Venture Capital - is often referred to as risk capital. It is capital invested by an outside party in a business, either as equity, or as a form of secondary debt. These funds rank behind all other secured creditors.

Acceleration Clause -a provision in a security agreement, mortgage note, bond, trust deed or credit agreement stipulating that the debt secured thereby, together with accrued interest, may become due and payable upon breach of some condition.

Aging -the process of analyzing receivables and payables by classification according to the length of time they have been outstanding.

Amortization - the gradual reduction of a debt by periodic payments over the term of the loan.

Appraised Value - an estimate of the current market value used in evaluating the assets pledged as security for a loan.

Arm's Length - a situation in which the parties to a transaction are not related or closely connected with each other.

Assignment - a transfer by one party (the assignor) of his rights or title in property to another (the assignee or assign). An assignment may take the form of a separate document or a clause in a mortgage, security agreement or other arrangement.

Back-to-Back Credit - credit opened by a finance house or bank on the strength of another credit and used in foreign trade. The foreign importer provides the finance house with the relevant documents, on the strength of which a credit is opened in favour of the exporter. This can then be used to back another credit for the exporter i.e., the first credit backs the second.

Balloon Note - a note calling for periodic payments which are not large enough to pay off the face amount of the note prior to maturity, so that a large final payment known as the "balloon" is due when the note matures.

Bankruptcy - proceedings under the Bankruptcy Act whereby the property of an insolvent person is taken over by a receiver or a trustee for distribution among the bankrupt's creditors, and by which the bankrupt is relieved of the unpaid balance of liabilities.

Benchmark - a measurement by which others are compared.

Bill of Lading - a document executed by common carriers acknowledging the receipt of goods and which serves as a document of title to the consigned goods.

Bonded Warehouse - a warehouse in which goods are stored without excise or customs duties being paid until they are removed from the warehouse.

Break-Even Point - point where revenue equals expenses.

Business Plan - an overview in words and numbers of the history of a business and its owners, the aims and objectives of a business, and proposals to achieve business goals.

Capacity - an assessment of your ability and willingness to repay a loan from anticipated future cash flow or other sources.

Capital Cost Allowance - the income tax term for depreciation.

Capital Investments - money used to purchase permanent fixed assets for a business, for example, machinery, land or buildings, as opposed to day-to-day operating expenses.

Cash Flow Forecast - an estimate of when, and how much money will be received and paid out of a business. It usually records cash flow on a month-by-month basis, for a period of two years.

Character - an assessment of your dependability as a person.

Chattel Mortgage - a pledge of business or personal property other than real estate - for example, equipment, automobiles, or other supplies required to operate a business - in exchange for a loan to purchase the property in question.

Collateral - property (real, personal or otherwise) pledged as security for a loan. Also, any supplementary promise of payment, such as a guarantee.

Comfort Letter - a letter by which the writer conveys assurance that something is or is not so, to the best of the writer's knowledge.

Commitment Fee - amount paid to a lender by a borrower (in addition to interest) as a fee for committing to make a loan.

Commitment Letter - a document by which the lender agrees to provide financing within a specified time and according to terms and conditions contained therein.

Comparative Statement - a form of financial-statement presentation in which current period results and positions are presented with corresponding figures for previous periods.

Conditional Sales Agreement - a contract of sale under which the transfer of title does not take place until specified payments have been made.

Conditions - the limits written into an agreement between a borrower and a lender specifying exactly what each party is expected to do in exchange for the benefits each will receive.

Consignment - a shipment of goods under an agreement whereby the receiving party undertakes to sell them as an agent for the shipper. The shipper retains title to the goods until they are sold.

Consortium - an association of independent organizations usually formed to undertake a specific project that requires skill and resources which are not possessed by any of the participants individually.

Cross-Collateralization - the process by which several loans advanced by one lender on different properties are secured by charges against each of the properties. A default on one loan normally constitutes default on another.

Debenture - a written instrument evidencing indebtedness, which is a direct obligation of the issuer, which is either secured or unsecured, and which may be negotiable.

Default - failure to comply with the terms or covenants in an agreement, or occurrence of any event which makes a loan document enforceable.

Demand for Payment - describes an action that may be taken by a lender when a borrower is in default of the loan terms as established in the commitment letter. The demand is usually a formal request for repayment of the outstanding balance in full, within a certain time frame.

Demand Loan - a loan that must be repaid in full, on demand.

Equity - the value of a business after all debts and other claims are settled. Also, the amount of cash a business owner invests in a business and/or the difference between the price for which a property could be sold and the total debts registered against it.

Escrow - the holding in trust of written agreement or other property (including money) by a third party until specified conditions are fulfilled.

Fixed Charge - a charge presently attaching property (commonly given, for example, in a debenture), which may be contrasted with a floating charge.

Floating Charge - a continuing charge on the assets of the grantor of the floating charge (usually in a debenture), but permitting the grantor to deal freely with the property in the usual course of business until the security holder intervenes to enforce its security or until there has been an event of default.

Indemnify - to make good a loss which one person has suffered in consequence of the act or default of another.

Indemnity - a collateral contract, security or assurance by which one party agrees to indemnify another.

Issued Capital - proportion of authorized capital stock for which subscriptions have been received and the stock allotted.

Joint and Several liability - a liability which allows the plaintiff to sue one or more of the parties to such liability separately, or together with all other such parties, at the plaintiff's option.

Joint Venture - a business undertaking entered into by two or more parties which is intended to terminate upon the completion of a specific project.

Key Man Insurance - life insurance on a key employee, partner or proprietor. The business is the beneficiary under the policy.

Letter of Credit - a letter issued by a bank authorizing the person named therein to draw money up to a specified amount from the bank's branches or correspondents, providing the conditions set out in the letter are met.

Limited Partnership - an unincorporated association (i.e. partnership) formed by two or more persons whereby the general partner is liable for the obligations of, and management of, the partnership, with the limited partners having no liability beyond the amounts contributed or agreed to be contributed by them as capital, and no management responsibilities.

Line of Credit - an agreement negotiated between a borrower and a lender establishing the maximum amount of money against which a borrower may draw. The agreement also sets out other conditions, for example, how and when the money is to be repaid.

Marketing Plan - an integral part of the business plan stating in words and numbers how, where and to whom a business proposes to sell its product and/or services.

Net Lease - a lease under which the tenant agrees to pay, in addition to the rent, expenses such as taxes, insurance, maintenance and other costs of the leased property.

Non-Recourse Loan - a loan which contains a clause that bars the lender from holding the borrower personally liable for any deficiency between the debt and the value of the security given.

Operating Loan - a loan intended for short-term financing, supplying cash flow support or to cover day-to-day operating expenses. It is part of a Line of Credit.

Performance Bond - instrument aimed at ensuring a service or contract is completed correctly. If this is not the case, then the bank issuing or guaranteeing the bond will be required to make a compensatory payment.

Personal Guarantee - a personal promise made by an individual on behalf of the borrower to repay the debt if the borrower fails to repay as agreed.

Personal Liability - the kind of responsibility for the payment or performance of an obligation which exposes the personal assets of the responsible person to payment of the obligation.

Prepayment - payment of all or part of the debt before its maturity date.

Prime Rate - the interest rate charged by banks to its preferential borrowers. It is the lowest rate of interest available to borrowers.

Promissory Note - a signed promise to pay a certain amount of money on demand or on a fixed date.

Proposal - under the Bankruptcy Act, the proposal made by a debtor to his creditors for the orderly payments of debts, without the debtor going into bankruptcy.

Prospectus - a complex document issued by a corporation or promoter in connection with the offering of securities or other investment opportunities containing specific information about the offeror's business, the type of investment, financial data and other pertinent facts in conformity with security regulations.

Ratio - comparison of two figures used to evaluate business performance. Examples of key ratios are the Debt/Equity Ratio and Return on Investment.

Receiver - a person appointed by the court or pursuant to a debt instrument, to take charge of the assets of an insolvent person or business and preserve them for sale and distribution to creditors. A receiver may also be appointed to take charge of property while that property is the subject of ongoing litigation.

Receivership - the state or condition of a corporation, partnership or individual over whom a receiver has been appointed for protection of assets for the benefit of creditors.

Receiving Order - a court order from which a court-appointed receiver takes authority respecting the property subject to the receivership.

Reverse Takeover - a term usually applied to a situation where ownership of a larger company is acquired by a smaller company. It usually requires an extensive reorganization of the acquiring company's capitalization.

Revolving Credit - an arrangement which permits a purchaser to charge purchases against an account every month, provided the balance does not exceed a predetermined credit limit. Monthly payments must be made on the account.

Right of First Refusal - right to have first opportunity to purchase when such becomes available, or right to meet any offer.

Sale and Leaseback - the sale of an asset with the vendor immediately renting the asset from the purchaser for long-term use.

Secured Creditors - those creditors who hold security for a debt, for the duration of the debt.

Senior Debt - debt that has a higher priority of claims than other debts.

Standby Commitment - a commitment from a lender to make a loan in a specified period of time on specified terms, but without specific intent as to whether funds will be drawn down, or, it drawn, the time or times at which drawdown is to occur.

Standby Fee - a sum of money (normally non-refundable) given by the borrower to the lender to keep a loan commitment effective for a specified period of time.

Subordinate Debt - debt that has a lower priority of claims than other debts.

Term Loan - a loan intended for medium-term or long-term financing to supply cash to purchase fixed assets, such as machinery, landing or buildings, or to renovate business premises.

Unsecured Creditor - a creditor who does not hold security from his or her debtor.

Winding Up - settlement of the accounts and liquidation of the assets of a partnership or corporation, for the purpose of making distribution and dissolving the concern.

Without Recourse - a phrase indicating that the holder of a document has no recourse to the person from whom he obtained it.

Working Capital - the excess of current assets over current liabilities.

Work-in-Progress - partly finished goods or contracts which are in the process of manufacture or completion at the end of an accounting period or at any particular time.

Ratios are the most commonly used method for analyzing financial statements. These ratios are meaningful only when they are compared over time, or with other companies, or within particular industries.

Ratios can provide an indication of financial health to both the business owner and the financial institution. While no single ratio is all encompassing, ratios can provide a basis on which to form a judgement.

Some Definitions and Terms Used in Financial Ratios

Cash Flow - net profit after tax plus depreciation/amortization, deferred taxes and other non-cash expenses.

Current Assets - total of cash, deposits, trade receivables, inventory and other assets due within one year.

Current Liabilities - total of trade accounts payable, bank operating loans and other debt due within one year.

Tangible Net Worth - net worth less intangible assets, for example, goodwill.