Ratios in Financial Statement Analysis

Financial statements provide financial ratios which give an analysis of a company's possible future success or failure
Financial statements provide financial ratios which give an analysis of a company's possible future success or failure (Image: Financial report image by janaka Dharmasena from Fotolia.com)

Accountants, investors and managers must keep track of financial ratios. Using financial ratios allows a person to see different sections of an business using strictly numbers. Using one financial ratio is like a single piece of a puzzle. By using multiple financial ratios, someone can put together the entire puzzle to get a clear picture of the company. This makes financial ratios a key concept in financial statement analysis. People use different types of ratio to gleam different parts of information from the company. Some ratios provide an idea on profitability, while others provide an idea on operational activities and so forth.

Liquidity Measurement Ratios

Liquidity ratios show how liquid a company is in the short-term. These show if the company can meet requirements to pay short-term debt, usually debt due in the next year. The main liquidity ratios are the current ratio, quick ratio, cash ratio and cash conversion cycle.

Profitability Indicator Ratios

Profitability indicator ratios show how well a company generates profits. These are important to see how efficient a company can create profits and a financial return on their assets. Examples of profitability indicator ratios are profit margin analysis, return on assets, return on equity and return on capital employed.

Debt Ratios

Debt ratios give investors an idea of how much of the firm's capital is made of debt. Debt ratios also show the capital of a company that comprises equity in the company. These are important because a firm must properly capitalize to function profitably in the future. Examples of debt ratios include debt ratio, debt-equity ratio, capitalization ratio and interest coverage ratio.

Operating Performance Ratios

Operational performance ratios provide an idea of how the firm operates its business. Operations include items such as collecting debt and turning inventory into sales. Examples of operating performance ratios are fixed asset turnover ratio and sales per employee ratio.

Investment Valuation Ratios

Investment valuation ratios provide investors with an idea of how well an investment will is at its current price. For example, a book value per share ratio provides an investors of how much cash they will receive per share if the firm is to liquidate its assets and cease operations. Example of investment valuation ratios are price per earnings ratio, book value per share ratio and dividend yield.

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