As discussed in the financial statements section, mathematical computations of the various items give rise to different types of ratios and they are collectively termed as Financial Ratios. These interactions between the three financial statements aid the investors, creditors, as well as the management of the company in understanding the current efficiency and performance while indicating the areas of improvement.
Ratios help measure the relative performance of different financial measures that characterize the firm’s financial health. Using the P&L statement, Balance Sheet and Cash Flow statement, investors can analyze the various type of ratios which measure the profitability, performance, management efficiency, liquidity, solvency, leverage, valuation, and many other parameters. This is termed as financial analysis.
The aim of financial analysis is to provide sufficient information about a company’s health and performance based on the various financial parameters, which in turn support the investing process.
Investors are suggested to consider the average of all balance sheet items during the calculations of any ratio involving an income statement and a balance sheet. This is to ensure that the balance sheet items are reflective of the activity during the various time periods of the year, similar to items reflected in the profit and loss statement. In the following section, the calculation and importance of various types of ratios are discussed in detail for easy understanding and usage.
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Rhea Khanna commented on April 26th, 2019 at 10:15 AM
Is doing a financial analysis of the ratios a necessity before investing with the company or is going through the financial statements sufficient?