Outline of Financial Ratios and their importance
Outline of Financial Ratios and their importance
Financial ratios are used to find the sectors that are most profitable in the economy and those companies that are most profitable within that sector. Liquidity, leverage, activity and profitability of the company are some of the examples of the financial ratios. These ratios are used to compare the growth of any two companies. They can also be compared with the companys previous performance to analyze its growth. Normally growing company is the one that shows increase in its revenue. But the question here is whether the companys revenue is increasing according to the companys size. By calculating financial ratios such as net profit margin, you will get the answer. Many websites which provide stock quotes also provide these ratios. This is very helpful for the investor as they dont need to calculate themselves. However it is very important for the investor to know how they are calculated, their meaning and their importance. Here let us have a quick overlook of some of the common financial ratios.
Liquidity Measures: It is nothing but handling the liabilities and debts of the company effectively within the stipulated time frame.
Leverage ratios: They compare the outstanding amount to the income or equity. Debt-equity ratio is an example of leverage ratio which measures the debt amount being used for financial operations. Times interest earned is another example and if it gets decreased, the investor will be at risk.
Activity ratios: They measure how the company is making use of its assets to make profits and to generate equity for stockholders. Inventory turnover, total asset turnover, account receivable turnover are some of the examples of activity ratios.
Profitability ratios: They compare the profit of the company to its sales, equity or assets. Net profit margin, Return on assets, Return on equity are some examples of profitability ratios.
