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Financial ratios are a key tool for analyzing a company's financial statements. These coefficients allow you to determine the effectiveness of business management, identify problems, make effective management or investment decisions. The users of financial ratios are business owners and other interested parties and investors.

Financial ratios are calculated based on the data presented in the financial statements: Profit and Loss Statement, Balance Sheet and Cash Flow Statement. The key financial ratios are as follows:

- Liquidity Ratios
- Efficiency Ratios
- Profitability Ratios
- Growth Ratios
- Leverage Financial Ratios

Each group includes a specific set of financial ratios. Let's look at examples of how liquidity ratios are calculated. Liquidity ratios are financial ratios that show a company's ability to meet its obligations. The group of liquidity ratios includes such financial ratios as:

- Cash Ratio
- Quick Ratio
- Current Ratio

Cash ratio. This ratio is calculated by dividing cash and cash equivalents by current liabilities using the formula:
Cash ratio = Cash & Cash Equivalents / Current Liabilities

The data for calculating this ratio is in the balance sheet. In the asset of the balance sheet, you need to find how much cash and cash equivalents are. Cash equivalents include securities and other highly liquid assets. In the liabilities of the balance sheet, you need to find how much the company's short-term liabilities are. Let's look at an example. Assume that the cash is $ 2.3 million and the company's cash equivalents are $ 0.9 million and the current liabilities are $ 1.4 million. The Cash Ratio is 2.3. Thus, the value of this ratio shows that the company has enough cash and cash equivalents to meet its short-term obligations.

Quick ratio. This ratio is calculated by dividing cash and receivables by current liabilities using the following formula:
Quick ratio = Cash & Cash Equivalents + Receivables / Current Liabilities

In the asset of the balance sheet, we find how much the company's receivables are, the rest of the data is taken as in the previous example. For example, accounts receivable are $ 0.8 million. The Quick Ratio is 2.9. The obtained value of the Quick Ratio is also high, which shows us that the company is able to quickly fulfill its short-term obligations.

Current Ratio. This ratio is calculated by dividing current assets by current liabilities using the formula:
Current Ratio = Current Assets / Current Liabilities

Current assets include cash and cash equivalents, receivables and inventories. In the asset of the balance sheet, we find how much the company's current assets are (can also be found by adding cash, accounts receivable and inventory). Let's say the company's current assets are $ 5.1 million. The Current Ratio is 3.6.

What do the values of the calculated liquidity ratios tell us? In general, the company is able to fulfill its short-term obligations and this is a good indicator, but on the other hand, we also see that the company has surplus current assets that could be used for investment.

The values of financial ratios can be compared with the average values for the industry in which the company operates. Also these ratios are compared with the indicators of past periods, i.e. the dynamics of these coefficients is analyzed, which shows how the company's resources are used, efficiently or ineffectively, the company's position is improving or deteriorating. In addition, you can calculate the liquidity ratio in relation to long-term liabilities. This will determine the company's ability to meet its long-term obligations.

by Olivia Davidson