28 Jul, 2025
4 mins read
Understanding a company’s financial health goes beyond just looking at profit or revenue. Ratio analysis breaks down important financial information using simple formulas. This method helps managers, investors and lenders see how well a business is really doing.
In this blog, we’ll explain what ratio analysis is, how ratio analysis in financial statements works, the types of ratio analysis, and the benefits of ratio analysis. We will also cover how to perform ratio analysis and show a complete ratio analysis example.
Ratio analysis is a method of comparing numbers from a company’s financial statements, like the income statement and balance sheet, to understand performance in areas like profit, cash, efficiency, and debt.
For example, if a company earns ₹10 for every ₹100 in sales, the net profit margin is 10%. That shows how well it manages costs and pricing.
Here’s a quick look at how to perform ratio analysis:
Collect figures from the latest income statement and balance sheet
Use standard formulas to calculate each ratio
Compare results with past years or other companies in the same industry
Analyse trends and decide if changes are needed
These numbers help you:
Track financial performance over time
Compare similar businesses
Spot areas that need improvement
There are many uses of financial ratios across different users:
Investors judge business performance and returns
Banks assess a company’s loan repayment capacity
Managers monitor day-to-day operations
Analysts compare companies within an industry
Regulators check the overall financial health
Using ratios regularly helps with decision-making and long-term planning.
There are four main types of ratio analysis, each focusing on a different part of the business:
These show whether a company can pay its short-term bills.
Current Ratio = Current Assets ÷ Current Liabilities
Quick Ratio = (Current Assets − Inventory) ÷ Current Liabilities
These tell how much money the company is making.
Net Profit Margin = Net Profit ÷ Revenue
Return on Equity (ROE) = Net Income ÷ Shareholder’s Equity
These show how well the company is using its resources.
Inventory Turnover = Cost of Goods Sold ÷ Average Inventory
Asset Turnover = Revenue ÷ Total Assets
These assess the company’s long-term financial strength.
Debt-to-Equity = Total Liabilities ÷ Shareholder’s Equity
Interest Coverage = EBIT ÷ Interest Expenses
To begin ratio analysis in financial statements, follow these steps:
Find the company’s most recent income statement and balance sheet
Plug the numbers into the right formulas
Compare with previous years or competing firms
Interpret what the ratios are telling you
It helps to use spreadsheets or financial software to avoid manual errors.
There are many benefits of ratio analysis, especially when reviewing a company’s finances:
Turns large data into simple, clear figures
Helps find risks or weaknesses early
Makes it easier to compare businesses
Builds confidence among banks and investors
Supports future planning and goal tracking
Let’s look at a simple ratio analysis example using ABC Ltd’s 2023 data:
Revenue: ₹500 crore
Net Profit: ₹50 crore
Current Assets: ₹300 crore
Current Liabilities: ₹200 crore
Shareholder’s Equity: ₹400 crore
Total Liabilities: ₹300 crore
EBIT: ₹80 crore
Interest Expenses: ₹20 crore
Now, we calculate:
Net Profit Margin = 50 ÷ 500 = 10%
Current Ratio = 300 ÷ 200 = 1.5
ROE = 50 ÷ 400 = 12.5%
Debt-to-Equity = 300 ÷ 400 = 0.75
Interest Coverage = 80 ÷ 20 = 4
This ratio analysis example shows that ABC Ltd is profitable, has good liquidity, and manageable debt.
Ratio analysis in financial statements is a useful and simple tool to understand a business’s financial health. When you know the types of ratio analysis and understand how to perform ratio analysis, you can make better business and investment decisions.
Ratio analysis is a method of comparing key numbers from a company’s reports to check how it’s doing. It helps understand areas like profitability, debt, and efficiency.
There are four - liquidity, profitability, efficiency, and solvency ratios. Each looks at a different part of the business.
Yes, investors use ratios to decide if a company is financially healthy before buying shares. It also helps compare different companies in the same sector.
Ratios are based on past data, which may not reflect future risks or opportunities. They also miss non-financial factors like brand value or customer loyalty.
Calculate your Net P&L after deducting all the charges like Tax, Brokerage, etc.
Find your required margin.
Calculate the average price you paid for a stock and determine your total cost.
Estimate your investment growth. Calculate potential returns on one-time investments.
Forecast your investment returns. Understand potential growth with regular contributions.
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