Financial Ratio Analysis
A financial ratio is a relative magnitude of two selected numerical values taken from the financial statements.
- Ratio analysis is a quantitative method of gaining insight into a company’s liquidity, solvency, operational efficiency, and profitability by studying its financial statements.
- Ratio analysis is a cornerstone of fundamental analysis.
- Investors and analysts employ ratio analysis to evaluate the financial health of companies by scrutinizing past and current financial statements. Comparative data can demonstrate how a company is performing over time and can be used to telegraph likely future performance. This data can also compare a company’s financial standing with industry averages while measuring how a company grows and performs against others within the same sector.
- Ratios can be expressed as a decimal value, such as 0.10, or given as an equivalent percent value, such as 10%. Example, some ratios are usually quoted as percentages, especially ratios that are usually or always less than 1, such as earnings yield, while others are usually quoted as decimal numbers, especially ratios that are usually more than 1, such as P/E ratio; these latter are also called multiples or times.
- Financial analysts use financial ratios to compare the strengths and weaknesses in various companies. If shares in a company are traded in a financial market, the market price of the shares is used in certain financial ratios.
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