Blog #01 - Financial Ratios & Analysis - Finance With Atul


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Thursday, March 25, 2021

Blog #01 - Financial Ratios & Analysis

Blog # 01


Financial Ratios & Analysis

Why do we calculate and analyze financial ratios? To understand – suppose you want to check your health then you will go through multiple medical tests like – you will check blood test report, sugar level, cholesterol and other tests. Similarly if you want to know the health of a company you have to go with the financial ratios of that company. Now the question arises why should we know about financial ratios of any company? First answer is that you can compare the financial status of two or more companies via these ratios. Secondly, if you invest in share market, then it is very important to analyze that company fundamentally and technically and fundamental analysis majorly relies on financial ratios, that why analysis of financial ratios becomes crucial. The financial ratios are classified in five categories namely:

#1. Profitability Ratios

#2. Liquidity Ratios

#3. Solvency Ratios

#4. Activity Ratios

#5. Valuation Ratios

Analysis of above mentioned ratios, you will get the idea or status of company’s profit margins, debt positions in long and short terms, operational efficiency, valuation of share price etc. 


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Profitability ratios tell us how good a company is at making money. As name is simple it tells the profit of a company and position of company in market competition while comparing it other company of same sector. Profitability ratios are calculated from income statements, sources of income and expenses. All these deciding parameters are declared in company’s results quarterly or yearly. The most common ratio of profitability ratio is profit margin. Profit margin is calculated by dividing the “Net Profit” by “Sales Revenue”. i.e. Profit Margin = (Net Profit / Sales Revenue), from here one can conclude that if profit margin is good then the company is also good means it follows direct relation.


Liquidity ratios tell us how comfortable a company is to pay its debts in the short terms. The popular ratio of liquidity ratio is “current ratio”. Current Ratio is calculated by dividing “Current Assets” by “Current Liabilities”. Current ratio = “Current Assets/Current Liabilities”. Here your current assets should be more in comparison to current liabilities, higher the current ration betters the results. 


Solvency ratio is same as liquidity ratio but the only difference is the “time”. This ratio tells how comfortable a company is to pay its long term debt? This covers the loan of the company. The ratio is also is known as Leverage Ratio or Debt Ratio. The popular ratio of this ratio is debt ratio. Debt ratio is calculated by dividing the “Total Liabilities” by “Total Assets”. This tells us how much debt is used to finance its assets? If the debt ratio is 0.8, it means 80% debt financing is present in company and it is not good for you and me. So here we can conclude that lower the debt ratio better the company.


Activity ratio shows the operational efficiency of a company. Here the question arises – what is the mean of “operational efficiency”? In simple language operational efficiency tells about a company that how well a company manages its working capital and long term assets to produce more. This is also known as efficiency ratios or asset utilization ratio. The popular ratio in this category is Inventory Turn Over ratio and it is calculated by dividing the “cost of goods sold” by “average inventory”. Mathematically you can see that higher the inventory turnover ratio better the results.


Valuation ratios guides in investment decisions. This ratio shows what is the right value of a company? The right value of a company may be evaluated from different ratios but there is popular ratio called EPS or earning per share through which you can guess the right value of a company. An earnings per share is calculated by dividing “Net Profit” by “No of Outstanding Shares”. The next most popular share is P/E ratio or Price to Earnings ratio and this ratio is calculated by dividing “price per share” by “EPS” or earning per share. P/E ratio is most popular ration, whenever you talk about share market you will hear about P/E ratio. Lower the P/E ration better is the share for investment (if you compare in same sector).

These are some popular ratio that are used to check the health of a company. But there are many ratios which can help you. Here I took only some examples to explain you.


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