Financial ratios are ratios that allow different economic data to be compared.
Financial ratios are quotients that allow comparisons to be made between different financial data . For a financial ratio to be valid, it must compare information that corresponds to the same period.
Knowing the etymological origin of the words that give shape to the concept is useful to understand the meaning of the notion. In this regard it is worth highlighting:
- Reasons derives from the Latin ratio , which means "reason."
- Financial emanates from the French verb financer , which can be translated as "defray a debt" and which, in turn, comes from the Latin finis , which is synonymous with "end."
Uses of financial ratios
Specifically, financial ratios, which are also known as financial ratios , are used with the clear objective of knowing the reality of a company or a specific division of it in order to determine if it can carry out the process. to assume certain obligations or even new projects.
These ratios always make sense when compared in a time series. An isolated financial ratio does not provide useful information regarding a company or an organization.
Different types
There are numerous financial reasons. One of the most common indicates the liquidity of an entity and is calculated by dividing the firm 's current assets by its current liabilities. In this way, the ratio reveals what monetary disposition the company has to assume its immediate obligations.
Another commonly used financial ratio is that it is revealed by the level of debt relative to assets . To calculate this ratio , you must divide the total debt (long-term liabilities plus current liabilities) by all assets.
In addition to the two financial reasons mentioned, those of liquidity and indebtedness, there are others:
- Profitability ratios that, as their name indicates, aim to measure the degree of profitability that a company has in terms of amounts, sales or capital. In this case, the operating profit margin, gross profit margin , asset turnover, net profit margin or return on investment are used as indicators.
- Coverage reasons . They proceed to measure the company's ability to cover its obligations. Some of the indicators used are the total coverage ratio and total liability coverage.
Financial ratios are used to carry out various analyses.
Financial ratios as analysis tools
By having different financial ratios, an analyst can compare different accounting periods of the company to see how it performed. From these evaluations , you can make projections.
In conclusion, it can be said that financial ratios are analysis tools that favor decision making. By knowing the liquidity ratio and comparing different periods, a company manager can determine if it is a good time to take on more debt , for example.
Typically, the analyst handles no less than ten financial ratios to have a broad overview of the company 's behavior. Within these reasons, some will be more important than others when making a decision.