Financial Ratios – what do they tell you?

What are financial ratios?
Financial ratios are standard ratios that are calculated using information in a company’s financial statements. Information presented in financial statements can be non-standard and confusing. Financial ratios provide a structure to analyze and understand the information presented in a company’s financial statements.

What are financial ratios used for?
Financial ratios are used for a variety of different purposes. They are used by company management to understand the overall health and performance of a company. They are used to compare the performance of a company against the general industry performance. They are used to compare a company with its competitors.

Financial ratios are also used by investors to analyze a company’s performance and thereby assess its value.

What are the different types of financial ratios?
The following are some common types of financial ratios:
i) Profitability Ratios measure a corporations ability to maximize its profits. A higher ratio is a sign of a profitable corporation.
ii) Liquidity Ratios measure a corporation’s ability to generate cash to pay off its short-term debt. A higher value indicates higher liquidity and thereby a greater ability to pay off short-term debt.
iii) Activity Ratios measure the time taken to convert goods produced to either sales invoices or cash.
iv) Debt Ratios measure the proportion of a company’s debt in relation to its assets.
v) Market Ratios compare market parameters eg. price with book parameters, or parameters from financial statements.