How to Compute Ratios on Financial Statements

While financial statements provide stakeholders with information on a company's financial position, a deeper analysis is often necessary to determine how well the company operates. Financial ratios provide information on a company's liquidity, asset turnover and financial leverage and profitability. Each ratio group presents a set of formulas that measure and assess a specific part of a company's financial information. The balance sheet is often the most important financial statement, as the majority of ratios use this information. The income statement is necessary to compute the profitability ratios.

Instructions

1. Gather the most recent balance sheet and income statement released by a company.

2. Identify which ratio group you desire to compute. For example, liquidity ratios measure a company's ability to pay short-term financial obligations.

3. Review the specific ratio to determine what information is necessary to compute the ratio. The current ratio, for example, requires current assets and current liabilities.

4. Compute the ratio. The current ratio divides current assets by current liabilities.

5. Compare the ratio result to the industry standard. Ratios by themselves do not provide much meaning. Comparing the ratios to the industry standard determines if the company is operating better or worse off compared to other businesses in the industry.

Tips & Warnings

• Visit the website in the Resources section to review the most common ratios applied to financial statements. The site provides detailed ratio formulas for analyzing financial statements.

• Companies can compare current-period financial ratios to previous-period ratios. This also provides a benchmark for comparison, similar to using the industry standard.

References

• "Fundamental Financial Accounting Concepts"; Thomas P. Edmonds, et al.; 2011

Resources

• NetMBA: Financial Ratios