The usefulness of ratios in assessing the financial health of a company
Financial ratios, derived from the income statement and balance sheet, facilitate the comparison of different companies in the same industry . They are used to identify the strengths and weaknesses of an organization relative to its competitors.
Financial ratios also help detect financial trends , developments and changes in a company’s performance. This is therefore a life down here in the cumberland mountains realizes real lever for anticipating potential problems.
Finally, they help investors, creditors and managers make informed decisions and reduce uncertainty . Indeed, financial ratios can measure a company’s profitability, liquidity and solvency and, consequently, the relevance of the company’s overall strategy.
The different financial ratios to measure a company’s performance
Profitability and profitability ratios
Profitability ratios measure a company’s ability to generate profits relative to its sales, assets, or equity. Some of the most commonly used ratios include:
- Net profit margin , which measures the overall profitability of the company.
- Return on equity, which indicates the wealth generated for the company’s owners.
- Return on assets, which provides information on how efficiently the company’s assets are used to generate profits.
Liquidity ratios
Liquidity ratios assess a company’s ability to meet its short-term financial obligations . In other words, they measure a company’s ability to europe email meet its debts payable in the coming months.
Solvency (and debt) ratios
Debt ratios assess a company’s ability to repay all debts .
- The total debt ratio measures the proportion of debts to the company’s total assets.
- The long-term debt ratio indicates the share of long-term debt in the company’s overall financing.
How to interpret a company’s financial ratios?
To properly interpret financial ratios, it is necessary to have a thorough knowledge of the company and industry standards.
Here are some examples to help you understand better:
- High profitability can indicate strong performance, but it is important to compare it to other companies in the same sector to be able to put this performance into perspective.
- A low liquidity ratio may signal a lack of cash to meet obligations, but it also reflects banks’ confidence in lending funds to the company.
- A high debt-to-equity ratio may indicate an over-reliance on borrowing, but the resulting leverage may be attractive to shareholders.
GOOD TO KNOW
Financial ratios must be analyzed in the company’s overall context, taking into account its objectives, strategy, and competitive environment. Above all, a single ratio cannot assess a company’s overall performance.
