What are Financial Ratios?
Financial ratios are metrics used to evaluate the financial health and performance of a company. They are calculated by dividing one financial metric by another to provide insights into the company's profitability, liquidity, efficiency, leverage, and other financial characteristics. Financial ratios can be used by investors, creditors, and management to evaluate a company's financial position and make informed decisions.
There are many different financial ratios that can be used to evaluate different aspects of a company's financial health. Some common examples include:
Profitability ratios: These ratios measure the company's ability to generate profits. Examples include gross profit margin, net profit margin, and return on assets.
Liquidity ratios: These ratios measure the company's ability to meet its short-term financial obligations. Examples include current ratio, quick ratio, and cash ratio.
Efficiency ratios: These ratios measure how efficiently the company is using its resources. Examples include asset turnover, inventory turnover, and accounts receivable turnover.
Leverage ratios: These ratios measure the company's level of debt relative to equity. Examples include debt-to-equity ratio, interest coverage ratio, and debt service coverage ratio.
Valuation ratios: These ratios measure the company's valuation relative to its financial performance. Examples include price-to-earnings ratio, price-to-sales ratio, and price-to-book ratio.
Financial ratios are useful for comparing a company's financial performance to industry benchmarks or to its own historical performance. They can also be used to compare multiple companies within the same industry. However, it's important to remember that financial ratios should be used in conjunction with other financial metrics and qualitative information to make informed decisions.