Shareholders need financial statements to evaluate their equity investments and help them make informed decisions as to how to vote on corporate matters. When evaluating investments, shareholders are able to glean meaningful data found on financial statements. There are a number of tools shareholders can use to make equity evaluations, and it is important for them to analyze their stocks using a variety of measurements. Available evaluation metrics include profitability ratios, liquidity ratios, debt ratios, efficiency ratios and price ratios.

Profitability ratios are a group of financial metrics utilized to gauge how well a company generates earnings. Return on equity, or ROE, reflects the percentage of shareholders’ equity returned as net income. This tool acts as a metric for profitability by showing the amount of profit companies generate with a shareholder’s investment. Operating profit margin is an important metric for evaluating the efficiency of a company's financial management.

Liquidity ratios are metrics that help shareholders determine how well a company handles its cash flow and short-term debts. The most commonly used liquidity ratio is the current ratio, which reflects current assets divided by liabilities and gives shareholders an idea of the company's efficiency in using short-term assets to cover short-term liabilities. Higher current ratios are a good indication the company manages its short-term liabilities well. The current ratio can also be useful in providing shareholders with an idea of the ability a company possesses to generate cash when needed.
Debt ratios indicate a company’s debt situation. The debt-to-equity ratio measures how much financial leverage a company has, a calculation of total liabilities divided by stockholder equity. A high debt-to-equity ratio indicates a company has vigorously funded its growth with debt. The interest coverage ratio measures the ease with which a company handles interest on its outstanding debt. A lower interest coverage ratio is an indication the company is heavily burdened by debt expenses.
Efficiency ratios help show how well companies manage assets and liabilities. The inventory turnover ratio reveals the number of times a company sells and replaces its inventory in a given period. The results from this ratio should be used in comparison to industry averages. Low ratio values indicate low sales and excessive inventory. High ratio values commonly indicate strong sales.

Price ratios focus specifically on a company's stock price and its perceived value in the market. The price/earnings, or P/E, ratio is an evaluation metric comparing current share price of a company’s stock with its per-share earnings. Higher P/E values indicate investors expect continued future growth in earnings. The P/E ratio is most helpful when compared to historical P/E values of the same company, those of companies in the same industry or to the market in general. The dividend yield ratio shows the amount in dividends a company pays out yearly in relation to its share price. Essentially, the dividend yield ratio is a measurement for the amount of cash flow received for each dollar invested in an equity.

These and other evaluation measurements can be calculated using the figures on a company's financial statements. Investors and market analysts depend on financial statements for equity evaluation. Evaluations are done using different measures because there is no single indicator that adequately assesses a company's financial position and potential growth.

  1. What common growth rates should be analyzed when considering the future prospects ...

    Learn about some of the most commonly used measures for evaluating a company's future growth prospects and analyzing it as ... Read Answer >>
  2. How can a company quickly increase its liquidity ratio?

    Discover what high and low values in the liquidity ratio mean and what steps companies can take to improve liquidity ratios ... Read Answer >>
  3. What are financial risk ratios and how are they used to measure risk?

    Explore some of the primary financial risk ratios that investors and analysts commonly use to evaluate a company's overall ... Read Answer >>
  4. How do the current ratio and quick ratio differ?

    The current ratio and the quick ratio are both liquidity ratios that measure how a company's ability to pay off its short-liabilities ... Read Answer >>
  5. What is the formula for calculating the current ratio?

    Find out what makes up the current ratio, how to calculate it, and what the result can tell you about a potential investment. Read Answer >>
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