What Is Financial Ratio Analysis?
Ratios express a mathematical relationship between two quantities and can appear in the form of a:
Percentage (%)
Rate (greater than, equal to, less than)
Proportion (numerator/denominator)
Financial ratio analysis (often referred to as ratio analysis) utilizes ratios and relationships between various financial statement accounts as basic tools to compare operational, financial, and investing performance of companies over time and against one another.
Ratios are often classified into four categories:
| Ratio Analysis | ||||
|---|---|---|---|---|
| Category | Liquidity Ratios | Profitability Ratios | Activity Ratios | Solvency Ratios (Coverage) |
| Purpose | Measure of a firm’s short-term ability to meet its current obligations | Measure of a firm’s profitability relative to its assets (operating efficiency) and to its revenues (operating profitability) | Measure of efficiency of a firm’s assets | Measure of a firm’s ability to repay its debt obligations |
| Example | Current ratio | Gross margin Operating margin Profit margin EPS | Inventory turnover Receivables turnover Payables turnoverAsset turnover | Debt to total capital Debt to equity Debt to EBITDA Debt to int. expense |
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