Financial ratios are powerful tools to help summarize financial statements and the health of a company or enterprise. Learn the most useful financial ratios here.
Frequently Asked Questions
  • Why are financial ratios critical in financial analysis?

    Financial ratios are useful tools for investors to better analyze financial results and trends over time. These ratios can also be used to provide key indicators of organizational performance, making it possible to identify which companies are outperforming their peers. Managers can also use financial ratios to pinpoint strengths and weaknesses of their businesses in order to devise effective strategies and initiatives.

  • What are the main uses of financial ratios?

    Financial ratios are widely used in financial analysis to determine how companies are performing internally and/or relative to one another. These ratios generally fall within one of four types of measurements: profitability, liquidity, solvency, and valuation. Understanding and applying ratios from all of these categories can enable investors to make smarter stock purchases and potentially avoid hefty losses.

  • What financial ratio measures risk?

    Several financial ratios can be used to measure a company’s risk level, particularly in relationship to servicing debts and other obligations. These financial ratios include the debt-to-capital ratio, the debt-to-equity (D/E) ratio, the interest coverage ratio, and the degree of combined leverage (DCL). Analyzing risk is useful for both bankers deciding whether to grant loans as well as private equity investors picking companies to invest in.

  • What is solvency vs. liquidity?

    Solvency and liquidity are both terms that are related to a business’ financial health. Solvent companies are those that own more in assets than they owe in debt, which means they have a greater capacity to meet long-term financial commitments. Companies that are adequately liquid can meet their short-term financial commitments and are able to sell assets to swiftly raise cash if need be. Healthy companies are those that are both solvent and possess adequate liquidity.

Key Terms

Explore Financial Ratios

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Cash Ratio: Definition, Formula, and Example
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Current Ratio Explained With Formula and Examples
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Debt-to-Equity (D/E) Ratio Formula and How to Interpret It
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Debt-to-Capital Ratio: Definition, Formula, and Example
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What Is the Debt Ratio?
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Equity Multiplier
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Fixed Asset Turnover Ratio Explained With Examples
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Gross Profit Margin (GP): Formula for How to Calculate and What GP Tells You
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Understanding Liquidity Ratios: Types and Their Importance
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Price-to-Sales (P/S) Ratio: What It Is, Formula To Calculate It
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Price-to-Book (PB) Ratio: Meaning, Formula, and Example
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Profitability Ratios: What They Are, Common Types, and How Businesses Use Them
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Quick Ratio Formula With Examples, Pros and Cons
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Financial Ratio Analysis: Definition, Types, Examples, and How to Use
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Return on Equity (ROE) Calculation and What It Means
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Return on Assets (ROA): Formula and 'Good' ROA Defined
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What Is a Solvency Ratio?
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Total-Debt-to-Total-Assets Ratio: Meaning, Formula, and What's Good
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Understanding the CAPE Ratio
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Compound Annual Growth Rate (CAGR) Formula and Calculation
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Book Value vs. Market Value: What's the Difference?
What's the Difference Between ROI and IRR?
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What's Considered a Good PEG Ratio?
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EBIT vs. EBITDA: What's the Difference?
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What Is a Good Expense Ratio for Mutual Funds?
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What Is the Formula for Calculating Free Cash Flow?
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Earnings Per Share (EPS) vs. Diluted EPS: What’s the Difference?
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How Do the Current Ratio and Quick Ratio Differ?
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How Do You Calculate Shareholders' Equity?
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What Is the Formula for Calculating Earnings per Share (EPS)?
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How to Calculate Return on Equity (ROE)
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The Difference Between Levered and Unlevered Free Cash Flow
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Understand the Weaknesses of the Price-to-Book (P/B) Ratio
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Average Annual Growth Rate (AAGR): Definition and Calculation
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Understanding the Book-to-Market Ratio
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Book Value Per Share (BVPS): Definition, Formula, How to Calculate, and Example
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Capital Asset Pricing Model (CAPM) and Assumptions Explained
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Capital Expenditure (CapEx) Definition, Formula, and Examples
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Understanding the Degree of Operating Leverage
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Dividend Payout Ratio Definition, Formula, and Calculation
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Debt-Service Coverage Ratio (DSCR): How To Use and Calculate It
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Dupont Analysis: The Dupont Formula Plus How To Calculate and Use It
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Earnings Per Share (EPS): What It Means and How to Calculate It
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Enterprise Value (EV)
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Expense Ratio
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Goodwill (Accounting): What It Is, How It Works, How To Calculate
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Gross Margin: Definition, Example, and Formula for How to Calculate
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Interest Coverage Ratio: The Formula, How It Works, an Example
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Inventory Turnover
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What Is Internal Rate of Return (IRR)?
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Leverage Ratio: What It Is, What It Tells You, How To Calculate
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What Is Financial Leverage, and Why Is It Important?
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What is Net Profit Margin? Formula for Calculation and Examples
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Net Present Value (NPV): What It Means and Steps to Calculate It
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What Is Operating Leverage?
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What Is Payout Ratio?
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Price/Earnings-to-Growth (PEG) Ratio: What It Is and the Formula
Rate of Return (RoR) Meaning, Formula, and Examples
Receivables Turnover Ratio Defined: Formula, Importance, Examples, Limitations
What Is the Reserve Ratio, and How Is It Calculated?
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  1. Demonstrating Value. "Financial Ratio Analysis." URL: https://www.demonstratingvalue.org/resources/financial-ratio-analysis