Financial Ratio
Explanation: A financial ratio is a relative magnitude of two selected numerical values taken from an enterprise’s financial statements. These ratios are used to evaluate various aspects of a company’s operating and financial performance such as its liquidity, profitability, efficiency, and solvency. Common financial ratios include the current ratio, debt-to-equity ratio, return on equity (ROE), and earnings per share (EPS).
Example: The current ratio, calculated as current assets divided by current liabilities, measures a company’s ability to pay short-term obligations. A current ratio of 2 means the company has twice as many current assets as it does current liabilities, indicating good short-term financial health.
Reference Link: For more information on financial ratios, visit Investopedia’s Financial Ratio.
FAQs:
- Why are financial ratios important?
- They provide insights into a company’s performance, financial health, and operational efficiency, aiding investors and managers in decision-making.
- How are financial ratios used in analysis?
- Ratios are used to compare companies within the same industry, assess trends over time, and evaluate financial statements.
- What is the difference between liquidity and solvency ratios?
- Liquidity ratios measure a company’s ability to meet short-term obligations, while solvency ratios assess long-term financial stability.
- Can financial ratios be misleading?
- Yes, if not used in context or if financial statements are manipulated, ratios can give a skewed view of a company’s financial health.
- What is the most important financial ratio?
- There is no single most important ratio; the relevance of each ratio depends on the specific aspect of financial health being analyzed.