Financial ratios or accounting ratios are used to assess the overall financial health of a company or other organization, making financial statements more readable. Ratios provide valuable information to management, owners, and creditors. Financial analysts use ratios to compare the strengths and weaknesses of different companies.
Generally, the following types of ratios are distinguished:
- Short-term solvency or liquidity ratios indicate a company's ability to cover its short-term obligations - in other words, whether the company has enough cash to pay its debts.
- Efficiency ratios (activity ratios) show how efficiently a company manages funds invested in different assets.
- Asset turnover
- Accounts receivable turnover
- Average collection period
- Inventory turnover
- Average days to sell the inventory
- Financial leverage or capital structure ratios (debt ratios) indicate how much debt a company uses or its ability to pay short-term and long-term obligations.
- Profitability ratios indicate the profitability of a company - how much profit is generated from the capital invested.
- Gross profit margin
- Operating profit margin
- Net profit margin
- Return on assets (ROA)
- Return on equity (ROE)
- Value or market ratios assess the adequacy of a company's market value.
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