Types of Financial Ratios

How can we structure financial ratios by function? By identifying which corporate financial performance areas we can measure and analyze with the ratios in question.

So what exactly can we measure and analyze using financial ratios?

1.      Liquidity (aka ‘solvency’). Ability of the company to pay its debt (meet its short-term financial obligation). This ability is measured, obviously, by liquidity ratios.

2.      Profitability. How much profit your company generates from your gross sales, assets, equity and the like. This ability is measured by profitability ratios. Which are the most popular metrics used in financial analysis, by the way.

3.      Leverage. The efficiency of corporate capital structure (i.e., its method of financing its assets) and the ability of the company in question to meet its long-term financial obligations. This ability is measured by profitability ratios. Aka ‘solvency ratios’.

4.      Efficiency of utilization of corporate resources. Well, not all resources, of course, just its assets. And not all efficiency – to measure that, you will need the whole CBA. Just the efficiency of converting assets into cash or sales. This ability is measured by efficiency ratios. Aka ‘activity ratios’ or ‘operating ratios’.  Or ‘asset turnover ratios’. Or simply ‘turnover ratios’.

5.      For a public company, it is important how public investors (the ‘market’) values the company in question. To measure and analyze this value, market ratios are used. Aka ‘valuation ratios’ (no surprise here).