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Financial Ratio Analysis

What are Financial Ratios?

Financial ratios are values created with the intent to gain useful insight into a company’s performance. They are derived from the company’s main financial statements (the income, balance, and cash flow statements) and are used to track the performance of the company as well as to compare and make judgements on the company’s progress.

The ratios are grouped into five different categories: Profitability, Market Value, Efficiency, Leverage and Liquidity.

The ratios help advisers understand a given company’s performance by comparing two values to one another. For example; Working Capital Ratio can help companies measure their liquidity, which refers to the speed and ease in which a company can turn assets into cash. It does this by dividing current assets by current liabilities in order to obtain the ratio. From here, advisers can compare the result to either previous results, or to other companies, in order to assess financial health.

Ratios can be used by a number of different stakeholders in order to help achieve results. Within the firm, ratios can be used by management and shareholders so that they can compare against previous results. Furthermore, alternatively analysts can use ratios to help compare companies to one another to help them decide which companies to invest in.

Ratios like these are either expressed in a decimal value (0.30) or alternatively the equivalent percentage value (30%).

Important ratios include:

The P/E (price-earnings) ratio, which measures the company’s share price to the company’s earnings per share. This ratio is used to value companies for sale. The Debt-to-Equity ratio assesses how much a company relies on borrowed money to fund its ventures, the higher the number, the higher the percentage of funding is done by borrowed money. ROE (Return on Equity) measures the profitability of a company.

To find out more about the various types of financial ratios, you can click the links here:

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