Mastering Financial Ratios

Financial Ratios: A Key Tool for Evaluating a Company's Financial Condition

• Financial ratios are relative magnitudes of two numerical values, used to evaluate the financial condition of a corporation or other organization.
• Financial ratios are used by managers, shareholders, and creditors to assess the strengths and weaknesses of a business.
• Financial analysts use ratios to compare the financial condition of various companies.
• Ratios can be expressed as decimal values or percentages.
• Ratios are calculated using data from financial statements such as balance sheets, income statements, and statements of cash flows.
• Financial ratios quantify different aspects of a business and are categorized according to the financial aspect they measure, such as liquidity, activity, debt, profitability, and market ratios.
• Financial ratios can be used for comparisons, but they are not useful unless benchmarked against something else, such as past performance or another company.
• Financial ratios may not be directly comparable between companies that use different accounting methods or follow various standard accounting practices.
• Different abbreviations may be used in financial statements, and there is no international standard for calculating summary data.
• Profitability, liquidity, activity, debt, and market ratios are the most commonly used types of financial ratios.
• Capital budgeting ratios are used to help managers make decisions about investments or projects that the company is considering to take.
• Formal methods such as payback period, net present value, and internal rate of return are used in capital budgeting.