Financial ratios are calculations that compare two (or more) pieces of financial data that are normally found in a company's financial statements.

Ratios can be invaluable to investors making decisions about companies in which they might want to invest because they can present perspectives of a company's financial performance and well-being from different standpoints.

A 澳洲幸运5官方开奖结果体彩网:variety of ratios is🦋 used by individual investors, institutional investors, and professional analystꦦs. Typically, financial ratios are organized into four categories: 

• 澳洲幸运5官方开奖结果体彩网:Profitability ratios
• 澳洲幸运5官方开奖结果体彩网:Liquidity ratios
• 澳洲幸运5官方开奖结果体彩网:Solvency ratios
• Valuation ratios or 澳洲幸运5官方开奖结果体彩网:multiples

General🌠ly, ratio𓄧s are used in combination to gain a fuller picture of a company.

Using a particular ratio as a comparison tool for more than one c෴ompany can shed light on the less risky or more attractive.

Additionally, an investor can compare a ratio derived from certain data today to the same ratio derived from a long period of historical data. This can provide them with a view of l꧃ong-term performance.

Investors can put ratios to use in different ways. All in all, finan🍃cial ratios ca🥂n provide a comprehensive view of a company from different angles and help investors spot potential red flags.

In this article, we'll look at each ratio category, some formulas, and some essential explanations.

Profitability Ratios

Profitability is a key aspect to analyze when considering an investment in a company. This is because high revenues alone don't necessarily translate into high earnings or high 澳洲幸运5官方开奖结果体彩网:dividends.

Essentially, profitability analysis seeks to determine whether a company will make a profit. It examines business productivꦬityꦫ from multiple angles using a few different scenarios.

Profitability ratios use data from a specific point in time to provide insight into how much profit a company generates and how that💯 profit relates to other important information ab꧋out the company.

These ratios are used to assess a business' ability to generate earnings relative to its revenue, 澳洲幸运5官方开奖结果体彩网:operating costs, assets, and 澳洲幸运5官方开奖结果体彩网:shareholders' equity over time.

Some key profitability ratios include:

• 澳洲幸运5官方开奖结果体彩网:Gross margin (and adjusted gross margin)
• 澳洲幸运5官方开奖结果体彩网:Operating margin 
• 澳洲幸运5官方开奖结果体彩网:Net profit margin
• 澳洲幸运5官方开奖结果体彩网:EBITDA margin
• 澳洲幸运5官方开奖结果体彩网:Operating cash flow margin
• 澳洲幸运5官方开奖结果体彩网:Return on assets (ROA)
• 澳洲幸运5官方开奖结果体彩网:Return on equity (ROE)
• 澳洲幸运5官方开奖结果体彩网:Return on invested capital (ROIC)
• 澳洲幸运5官方开奖结果体彩网:Return on investment (ROI)

One of the leading ratios used by inves🅷tors for a quick check of profitability is the net profit margin.

Example: Net Profit Margin

$\text{Profit Margin}=\frac{\text{Net Income}}{\text{Revenue}}$Profit Margin=RevenueNet Income​

This ratio compares a company’s 澳洲幸运5官方开奖结果体彩网:net income to its revenue. In general, the higher a 澳洲幸运5官方开奖结果体彩网:company's profit margin, the bet👍ter. A net profit margin of 1, or 100%, means a company is converting all of its revenue to net inc𒉰ome.

Profit margin 🌜levels vary across industries and time periods. Thus, it is helpful to look at a company's net profit margin versus the industry and the company’s historical average.

With net profit margin, there can be a few 澳洲幸运5官方开奖结果体彩网:red flags to watch out for. For instance, a company that has decreasing net profit margins 澳洲幸运5官方开奖结果体彩网:year-over-year could be dealing with changing market conditions, increasing💃 competition, or rising costs.

A company with a very low profit margin may need to focus on decreasing e🌄xpenses through wide-scale strategic initiatives.

A high net profit margin relative to the industry may indicate a significant advantage in 澳洲幸运5官方开奖结果体彩网:economies of scale, or, potentially, some accounting schemes that may 𓃲not b♌e sustainable for the long term.

Liquidity Ratios

澳洲幸运5官方开奖结果体彩网:Liquidity relates to how quickly and reliably a comp🐻any can pay its obligations and debts. ♒It indicates how well company assets cover expenses.

Liquidity ratios give investors an idea of a company’s 澳洲幸运5官方开奖结果体彩网:operational efficiency. They also show how quickly and easily a company can generate cash to purchase additional assets or to repay 澳洲幸运5官方开奖结果体彩网:creditors. This need can ﷽arise in an emergency situation or in t𓂃he normal course of business.

Some key liquidity ratios include:

• 澳洲幸运5官方开奖结果体彩网:Current ratio
• 澳洲幸运5官方开奖结果体彩网:Quick ratio
• 澳洲幸运5官方开奖结果体彩网:Cash ratio
• 澳洲幸运5官方开奖结果体彩网:Cash conversion cycle (CCC)
• 澳洲幸运5官方开奖结果体彩网:Operating cash flow ratio
• 澳洲幸运5官方开奖结果体彩网:Receivables turnover
• 澳洲幸运5官方开奖结果体彩网:Inventory turnover
• 澳洲幸运5官方开奖结果体彩网:Working capital turnover

Example: Current and Quick Ratios

The current and quick ratios are great ways to assess the𒁏 liquidity of a firm. The ratios are similar.

The current ratio is calculated by dividing 澳洲幸运5官方开奖结果体彩网:current assets by 澳洲幸运5官方开奖结果体彩网:current liabilities. Since current assets and current liabiꦦlities ♏represent activity in the upcoming 12 months, this ratio can provide insight into the firm’s short-term liquidity.

A higher current ratio is favorable as it represents the number of times current assets can cover current liabilities. However, one that's too high might indicate that a company isn't utilizing its excess cash as well as it could to pursue growth.

The quick ratio differs slightly. Its calculation subtracts 澳洲幸运5官方开奖结果体彩网:inventory from cuꦯrrent assets before they're divided by curre🌌nt liabilities. This ratio can present better insight into the short-term liquidity of the firm because of the exclusion of inventory.

A higher quick ratio indicat♌es more short-term liquidity and good financꦆial health.

Both of the formulas below provide the same result. You can choose which to use based on the information presented on the financial statement that you're reviewing.

Solvency Ratios

Solvency ratios, also known as leverage ratios, are used by investors to see 𓄧how well a company can deal with its long-term financial obligations.

As you might expec𝓰t, a company weighed down with debt is probably a less favorable investment than one with a minimal amount of debt.

Some popular solvency ratios include:

• 澳洲幸运5官方开奖结果体彩网:Debt-to-total-assets
• 澳洲幸运5官方开奖结果体彩网:Debt-to-equity
• 澳洲幸运5官方开奖结果体彩网:Time interest earned
• 澳洲幸运5官方开奖结果体彩网:Interest coverage ratio
• Net income to liabilities
• 澳洲幸运5官方开奖结果体彩网:Times interest earned 

Debt-to-assets and debt-to-equity are two ratios often used for a quick check of a company’s debt levels. They show how debt stacks up against the categories of assets and equity on the 澳洲幸运5官方开奖结果体彩网:balance sheet. They give i𓆉nvestors an idea of a company's financial health as it relates to a potential burden of debt.

Example: Debt-to-Assets

The total-debt-to-total-assets r🎃atio is used to determine how much of a company is financed by debt rather than shareholder equity.

It is calculated as follows:

$\begin{aligned}&\text{Total Debt to Total Assets}\ =\ \frac{\text{STD}\ +\ \text{LTD}}{\text{Total Assets}}\\&\textbf{where:}\\&\text{STD}=\text{short term debt}\\&\text{LTD}=\text{long term debt}\end{aligned}$​Total Debt to Total Assets = Total AssetsSTD + LTD​where:STD=short term debtLTD=long term debt​

A smaller percentage is better becaཧuse it means that a company ꦓcarries a smaller amount of debt compared to the amount of its total assets. The greater the percentage of assets, the better a company's solvency.

Remember, lenders typically have the first claim on a company's assets if it's required to 澳洲幸运5官方开奖结果体彩网:liquidate. A lower debt-to-assets ratio typically indicates 🌃less risk.

When using this ratio to analyze a company, it can help to look at both the🌱 company growth phase and the industry as a whole.

Iꦗt's not unrealistic for a younger company to have a highཧ debt-to-total-assets ratio (with more of its assets financed by debt) as it hasn't had a chance to eliminate its debt.

Valuation Ratios

Valuation ratios are often referred to by the media. They're used to analyze the attractiveness of a potential investment in a company.

These metrics primarily incorporate the price of a company's publicly traded stock. They can help investors understand how inexpensive or expensive a stock is relative to the market.

In general, the lower the ratio level, the more attractive an investment in a company becomes. Often, analysts will t𒈔ake the reciprocal of a valuation ratio, or its multiple, as a measure of relative value.

Some popular valuation multiples include:

• 澳洲幸运5官方开奖结果体彩网:Price-to-earnings
• 澳洲幸运5官方开奖结果体彩网:Price-to-book
• 澳洲幸运5官方开奖结果体彩网:Price-to-sales
• 澳洲幸运5官方开奖结果体彩网:Price-to-cash flow

Example: Price-to-Earnings

The price-to-earnings (P/E) ratio is a well-known valuation ratio. It compares a company's stock price to its earnings per-share. It can help investors determine a stock's potential for growth. In addition, the P/E ratio can s💖ignal whether a stock is undervalued or ov♈ervalued.

The P/E ratio is calculated as follows:

$\text{Price to Earnings} = \frac{\text{Market Value Per Share}}{\text{Earnings Per Share (EPS)}}$Price to Earnings=Earnings Per Share (EPS)Market Value Per Share​

Basically, the P/E tells you how much investors are willing to pay for $1 of earnings in a company. So, a higher ratio indicates that investors ཧare expecting higher earnings growth.

Investors often prefer a lower P/E because they'd have to spend less mone🐽y for each dollar of earnings.

It should be clear that investors have to compare the ratio they calculate to the same ratio for other companies in the same industry, or to the industry average, to get an idea of what's higher or lower.

The Bottom Line

Financial ratios can be used to compare companies as prospective investments. They can help investors evaluate stocks within an industry. Moreover, they can provide a measure of a company today that can be compared to its historical data.

The information you need to calculate ratios is easy to come by. Every figure can be found in a company's 澳洲幸运5官方开奖结果体彩网:financial statements. Once you have the raw data, you can plug it into your financial analysis 🌳༒tools and put it to work for your benefit.

Sometimes, new investors avoid financial ratios because they don't know how to interpret them or use them. So take the time to understand what financial ratios tell you and how to calculate them. Doing so can help you gain greater confidence in your investment decisions and avoid investment mistakes.