Financial ratios are crucial analytical tools used to evaluate various aspects of a company's financial

health, performance, and efficiency. They are derived from the company's financial statements—
specifically the balance sheet, income statement, and cash flow statement. These ratios can be
categorized into several types, each serving a different purpose in financial analysis. Here's an
overview of the main categories and some key ratios within each:

1. Liquidity Ratios

These ratios measure a company's ability to meet its short-term obligations with its short-term
assets. They are crucial for assessing the financial stability of a company in the short run.

 Current Ratio: Current Assets / Current Liabilities

 Quick Ratio (Acid-Test Ratio): (Current Assets - Inventories) / Current Liabilities

2. Solvency Ratios (Leverage Ratios)

Solvency ratios assess a company's ability to meet its long-term obligations and its
financial leverage.

 Debt to Equity Ratio: Total Debt / Total Equity

 Interest Coverage Ratio: EBIT (Earnings Before Interest and Taxes) / Interest
Expense

3. Efficiency Ratios (Activity Ratios)

These ratios evaluate how effectively a company uses its assets and liabilities internally.

 Inventory Turnover Ratio: Cost of Goods Sold / Average Inventory

 Receivables Turnover Ratio: Net Credit Sales / Average Accounts Receivable

4. Profitability Ratios

Profitability ratios measure a company's ability to generate earnings relative to its

revenue, assets, equity, and other financial aspects.

 Gross Profit Margin: (Revenue - Cost of Goods Sold) / Revenue

 Net Profit Margin: Net Income / Revenue
 Return on Assets (ROA): Net Income / Total Assets
 Return on Equity (ROE): Net Income / Shareholder's Equity

5. Market Value Ratios

Market value ratios are used to evaluate the share price of a company's stock.

 Price to Earnings Ratio (P/E): Market Price per Share / Earnings per Share
 Price to Book Ratio (P/B): Market Price per Share / Book Value per Share

6. Cash Flow Ratios

These ratios focus on the cash flows of a company, providing insights into its cash
management.

 Operating Cash Flow Ratio: Operating Cash Flow / Current Liabilities

 Cash Conversion Cycle: Days Inventory Outstanding + Days Sales Outstanding -
Days Payable Outstanding

Usage

Financial analysts, investors, creditors, and the company's management use these ratios for various
purposes, including assessing financial health, making investment decisions, evaluating
creditworthiness, and strategic planning. Each ratio provides insights into different aspects of the
company's financial performance and position, making them indispensable tools for financial
analysis.