Business Alchemy Lesson 12–A Word on Ratios and Little Plastic Army Men (Part One)

15 Mar Business Alchemy Lesson 12–A Word on Ratios and Little Plastic Army Men (Part One)

When my littlest brother was much younger than he is now, he used to ‘play’ by lining up his toys.  Organizing was playing for my brother.  Well that just seemed wrong to me so I would patiently wait for him to finish lining up his toys, like little plastic army men, by color and separate the armies of each color even more into styles, and then I would bump the table or happen to drop something or trip and fall right into the middle of his toys.  Naturally he would cry and I would take great satisfaction in the fact that he had to organize his armies all over again, after all that is just not playing, right?

The point of this story has nothing to do with me being immature and obnoxious and everything to do with my little brother’s organizing.  Accountants are usually quite organized.  The organization may not be quite so obvious to the untrained eye however.  The profit and loss statement, the cash flow statement and the balance sheet are all very organized.  The trick is to be able to take the numbers that are well organized into accounts and be able to use the numbers to make decisions.

That is where ratios come into play.  It is so much more fun to look at ratios like a war with little plastic army men than to memorize a bunch of equations.  You see, with the little plastic army men there are two main questions that are important.  The first question is who do we want to win.  We have to pick the side that we want to throw our support behind so we know if we are winning or losing the war.

Picking a winning side means looking at a ratio and deciding which side of the ratio we would like to win.  Ratios, by definition, involve dividing.  Whenever you divide there is the number on top (called the numerator) and the number on bottom (called the denominator).  To pick the side that we want to win simply means deciding if we want the numerator or denominator to win.  This will become more obvious as we get into the actual ratios, but a quick example would be assets versus liabilities; do we want the assets to win or the liabilities in a company?  You better answer assets!  Anyway, that is the first question.

We will stop with the first question for now so you can let that sink in a little.  Part two will address the second question.  In the meantime remember...