ANSWER

Financial Ratio Analysis is the evaluation and interpretation of a company’s financial data using standard financial ratios or accounting ratios to determine a company’s financial state or condition.  A financial ratio or accounting ratio is a ratio of two values that are taken for a company financial statements (Balance Sheet, Income Statement, Statement of CashFlows, Statement of Retained Earnings )  There are many standard financial ratios used that have been identified as critical indicators of the financial performance of a business.  In addition to measuring a business’ health, they can be used for strategic planning and decision making.  Financial ratios can be grouped into categories based on the financial aspect of the business that they measure.  The categories are:

• Leverage/ Debt Ratios - disclose to what extent debt is used in a company’s capital structure which may indicate the company’s ability to repay long-term debt.
• Liquidity Ratios – reflect a company’s short term financial situation and availability of cash.
• Operational Ratios – indicate a company’s operational efficiency and how well assets are utilized.
• Profitability Ratios - measures the rate of return that a company achieves through the use of its assets and control of its expenses.
• Solvency Ratios - measure a firm’s ability to generate cash flow by converting its non-cash assets to cash in order to honor its financial obligations. 

Financial ratio analysis is commonly used to compare a company’s current financial performance to its past performance, also called trend analysis, or it can be used to compare against other businesses within the same industry.  Comparison to businesses in different industries provides little value since different industries have different risks which may require different capital requirements.

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Chris Adams
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