DEFINITION of Key Ratio
Key ratios are the main mathematical ratios that illustrate and summarize the current financial condition of a company. Key ratios can be used to easily obtain an idea of a company's financial status. Companies that are in good condition financially will have superior ratios to those that are performing poorly. Key ratios take data from the subject company's financial statements such as the balance sheet, income statement and statement of cash flows. Items on these statements are compared with other items to produce ratios that represent key aspects of the company's financial picture such as liquidity, profitability, use of debt and earnings strength.
BREAKING DOWN Key Ratio
There are several different key ratios used by analysts to examine a company's financial condition. Often, the ratios commonly used will vary by industry. The same ratios used to compare technology companies are not the same ratios usually used to compare banks. Ratios used to compare banks include the capital to assets ratio, the loan loss reserves to total loans ratio, the liquidity ratio and many others. These ratios provide direct measures of different specific aspects of a bank's assets, liabilities and cash flow.
Using Key Ratios
For example, Bert is an analyst with XYZ Research and wants to learn more about ABC Corp. He goes to ABC Corp's investor relations website and pulls their financial statements. Bert wants to find out how efficient ABC Corp is at managing its expenses to generate profits, so he starts to compute some of ABC Corp's profitability ratios. He pulls some net income, net sales, net profit and net assets figures and starts to compute some profitability ratios such as return on assets (ROA) and profit margin ratios.