Ratio—the term is enough to curl one's hair, conjuring up those complex problems we encountered in high school math that left many of us babbling and frustrated. But when it comes to investing, that need not be the case. In fact, there are ratios that, properly understood and applied , can help make you a more informed investor. Assessing the health of a company in which you want to invest involves understanding its liquidity —how easily that company can turn assets into cash to pay short-term obligations. The working capital ratio is calculated by dividing current assets by current liabilities.
6 Basic Financial Ratios and What They Reveal
Ten Ratios for Financial Statement Analysis - dummies
Calculating the ratios is relatively easy; understanding and interpreting what they say about a company's financial status takes a bit more work. Ratios serve as a comparative tool of analysis for liquidity , profitability , debt , and asset management , among other categories—all useful areas of financial statement analysis. Analysts compare the ratios for a given firm to the ratios of other firms in the same industry and against previous quarters or years of historical data for the firm itself. Performing an accurate financial ratio analysis and comparison helps companies gain insight into their financial position so that they can make necessary financial adjustments to enhance their financial performance. When choosing which ratios to work with, companies use several standard ratios most often.
Financial Ratio Analysis
Ratio analysis is a quantitative method of gaining insight into a company's liquidity, operational efficiency, and profitability by studying its financial statements such as the balance sheet and income statement. Ratio analysis is a cornerstone of fundamental equity analysis. Investors and analysts employ ratio analysis to evaluate the financial health of companies by scrutinizing past and current financial statements. Comparative data can demonstrate how a company is performing over time and can be used to estimate likely future performance.
Current ratio. The current ratio is also called the working capital ratio, as working capital is the difference between current assets and current liabilities. This ratio measures the ability of a company to pay its current obligations using current assets. The current ratio is calculated by dividing current assets by current liabilities. This ratio indicates the company has more current assets than current liabilities.