Financial Ratio: Meaning, Definition, Types, Uses, Examples (2024)

FAQs

Financial Ratio: Meaning, Definition, Types, Uses, Examples? ›

Several financial ratios can be used to measure a company's risk level, particularly in relationship to servicing debts and other obligations. These financial ratios include the debt-to-capital ratio, the debt-to-equity (D/E) ratio, the interest coverage ratio, and the degree of combined leverage (DCL).

What is Financial Ratio? It is a calculation where financial values are determined to get an insight into the overall financial health of a company and its market position. The value thus obtained can be used in the balance sheet, statement of cash flows, and other important financial statements.

Common financial ratios come from a company's balance sheet, income statement, and cash flow statement. Businesses use financial ratios to determine liquidity, debt concentration, growth, profitability, and market value.

In general, financial ratios can be broken down into four main categories—1) profitability or return on investment; 2) liquidity; 3) leverage, and 4) operating or efficiency—with several specific ratio calculations prescribed within each.

A ratio is an ordered pair of numbers a and b, written a / b where b does not equal 0. A proportion is an equation in which two ratios are set equal to each other. For example, if there is 1 boy and 3 girls you could write the ratio as: 1 : 3 (for every one boy there are 3 girls)

There are six basic ratios that are often used to pick stocks for investment portfolios. Ratios include the working capital ratio, the quick ratio, earnings per share (EPS), price-to-earnings (P/E), debt-to-equity (D/E), and return on equity (ROE).

Most analysts prefer would consider a ratio of 1.2 to two or higher as adequate, though how high this ratio depends upon the business in which the company operates. A higher ratio may signal that the company is accumulating cash, which may require further investigation.

Generally speaking, a good quick ratio is anything above 1 or 1:1. A ratio of 1:1 would mean the company has the same amount of liquid assets as current liabilities. A higher ratio indicates the company could pay off current liabilities several times over.

What is a good debt ratio? ›

35% or less: Looking Good - Relative to your income, your debt is at a manageable level. You most likely have money left over for saving or spending after you've paid your bills. Lenders generally view a lower DTI as favorable.

Financial ratios offer entrepreneurs a way to evaluate their company's performance and compare it other similar businesses in their industry. Ratios measure the relationship between two or more components of financial statements. They are used most effectively when results over several periods are compared.

Financial ratio analysis is often broken into six different types: profitability, solvency, liquidity, turnover, coverage, and market prospects ratios. Other non-financial metrics may be scattered across various departments and industries.

The current ratio measures a company's capacity to pay its short-term liabilities due in one year. The current ratio weighs a company's current assets against its current liabilities. A good current ratio is typically considered to be anywhere between 1.5 and 3.