Financial Ratios

Financial ratios measure liquidity, activity, leverage, and profitability of a company as a ratio to be able to compare it to other companies, other sectors, and other times. Financial ratios can be used to find the most profitable sectors of the economy and to find the most profitable companies within those sectors. A company can also be compared to its past performance, to see if certain measures are increasing or decreasing, or not moving at all. For instance, a growing company increases revenues and usually profits, from year to year, but is the company becoming more or less profitable as it grows in size? A financial ratio, such as net profit margin, can provide the answer.

Financial ratios are often used to screen stocks by stipulating that a company's financial ratio be a certain minimum or maximum amount, depending on the investor's objective.

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The numerators and denominators of financial ratios come primarily from either the company's balance sheet or its income statement. Many websites that provide stock quotes also provide most of the common financial ratios, so investors rarely have to calculate it themselves, although understanding how financial ratios are calculated helps the investor to understand what they mean and their relative importance as well as understanding how they are limited.

Here is a quick overview of the most common financial ratios, with more detailed information in the following articles: