A financial ratio is a comparison between the relationship of different numbers on the financial statements. It is an efficient way of looking at the performance metrics of a company and gives many insights into operational efficiency, the financial strength of a company, and the strengths and weaknesses within the company.
Analyzing financial ratios can be done in many ways for many varied reasons. One is to compare the numbers and percentages of your own company’s metrics opposed to your competitor’s. It can be used to see the contrast of your percentages versus a company in a different market. It is also common to compare your own numbers to those from previous years. That is a great way to view a company’s growth patterns over time. You always want to strengthen your margins and manage your costs.
There are many financial ratios within the business world, and some are more common than others. Some popular ones include the current ratio, liquidity ratio, equity ratio, and profitability:
Current Ratio – Determines the company’s abilities to pay down short term debts. Current assets divided by current liabilities.
Liquidity Ratio – Analyzing if the company has the adequate cash to meet their short term needs.
Equity Ratio – Determines how much of company assets are funded by equity as opposed by liabilities. Total equity divided by total assets.
Profitability – Examining how the company generates money from the products/services they sell.
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