FINANCIAL BASICS: FINANCIAL RATIOS

Financial statements are quite tricky to read and often don’t tell us much in isolation.

However, they can reveal more information than meets the eye. A way to extract this useful information is to use financialratios, which we create using information from the financial statements.

Who uses financial ratios, and for what?

  1. Business owners and management teams use ratios to assess performance and make decisions

  2. Creditors use ratios to assess the ability of companies to pay back loans.

  3. Financial analysts use them to compare companies and identify profitable investments

  4. Investors use them to assess stocks and investment opportunities. For example, if you're looking to buy a company or invest in stocks in a company, you should use multiples to gauge whether the company is cheap or expensive or is doing well or not.

The types of ratios can be grouped according to their functionality. There are: profitability ratios, liquidity ratios, efficiency ratios, debt ratios and market valuation ratios.