Financial Ratios

What are financial ratios?

Financial ratios are simple formulas or fractions that you can use to compare two different items from a company’s financial statements.

The reason we do this is because these ratios can give you a lot more insight into how the company is performing than by looking at those financial statement line items separately.

Let’s say you are a brand new company and were looking at the balance sheet of your company. You have current assets of $1,000 split between cash ($500) and inventory that you intend to sell ($500).

This is a startup, so you’re doing the work yourself, but you needed materials to actually build the product you’re selling. You went to a supplier and got the materials needed and, for that, you paid $2,000 on net 30 terms.

That $2,000 is your current liabilities that you need to pay within 30 days and if you just looked at current assets and liabilities as lines on your balance sheet, it doesn’t tell you much.

But if we use the “quick ratio“, which is a measure of the liquidity of your company, we can see a problem:

You only have $500 in cash. This is only enough to cover 25% of your liabilities. What if you don’t sell your inventory in the next 30 days? Your business will struggle to repay the supplier and you’ll be in real trouble.

By using financial ratios, you can compare a lot of different business metrics to more deeply understand just what is going on with the company.

There are generally five types of financial ratio: (1) profitability, (2) liquidity, (3) management efficiency, (4) leverage, and (5) valuation & growth.

List of financial ratios

We’ve covered a lot of financial ratios on Study Finance (too many to list all on one page).

Below are the latest we’ve written in each category of ratio and, if you want more, you can click the links above to explore the ratio types and all of the examples we have.

Each ratio article will provide a detailed overview of the ratio, what it’s used for, and why.

They also explain the formula behind the ratio and provide examples and analysis to help you understand them.