Financial Ratio Analysis
A financial ratio analysis is a quantitative examination of the information found within a company's financial statements. This analysis is based off of the various line items in a company's balance sheet, income statements, or cash flow statements. A financial ratio analysis then can evaluate the different aspects of a company's performance. Financial ratio analysis general covers seven areas: profitability, liquidity, efficiency, market prospect, investment leverage, coverage, and solvency.
Ultimately, a financial ratio analysis is the mathematical comparison of data. It is the relationship between these numbers that allows investors and management to understand the financial health and performance of a company. Additionally, these ratios can be used to compare one company to another. Such analyses can allow a company to evaluate its strengths and weaknesses, both internally and against competition.
Investors are generally familiar with some of the more common, fundamental ratios, including current ratio, return on equity, debt to equity ratio, dividend payout ratio and the price/earnings (P/E) ratio. These are also some of the easier financial ratios to calculate. A financial ratio analysis of a company is often compared to industry averages. For example, if the average P/E ratio of all companies on the S&P 500 index is 15, stocks with lower P/E ratios can be considered to be undervalued.