How to Evaluate Financial Strength Using Ratio Formulas


You can use financial ratio formulas to determine a company's stability, long-term growth and investment potential. Using these basic ratio formulas can give you an objective insight into a company's financial strength.

Understand a company's leverage or borrowing power ratio. Leveraging is the amount of debt in relation to assets and equity. Ratio formulas measuring financial leveraging include debt to equity and asset turnover.

Determine a company's financial liquidity ratio. Financial liquidity is figured by using formulas dividing total assets by total liabilities.

Estimate a company's operating ratio or use of capital. To find the ratio of working capital, divide the company's total day-to-day earnings by costs.

Measure a company's profitability ratio. Profitability is measured with a number of formula ratios, but the simplest is gross profit margin. To determine gross profit margin, divide gross profit by total revenue. This should show some variation but remain mostly stable as an indicator of good financial practices.

Evaluate a company's financial solvency. Solvency is stability over time or the likelihood of a company falling into bankruptcy. Ratio formulas used to measure this include debt to equity, debt to assets, fixed costs or interest ratios.

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