Financial ratios help us measure different aspects of an organization’s performance. They include financial results, operational efficiency, liquidity position, and structure of capital. In addition, financial ratios can be used to compare the organization’s performance against its competitors as well as the overall industry. Financial ratios also help the management monitor operations and identify areas of problem.

Financial ratios that measure liquidity include current ratio and quick ratio (Richard). Liquidity ratios tell about the management’s ability to manage its day to day operations. High liquidity ratios are desirable since they indicate a low probability of an organization going out of business. Operation performance ratios include fixed asset turnover ratio and sales-revenue per employee ratio. Performance ratios tell about the operational efficiency of the management. The firms aim for higher performance ratios because higher efficiency results in higher profits. Profitability ratios include return on equity (ROE) and return on assets (ROA) ratio.

Profitability ratios tell how well the organization is doing in terms of generating returns for its shareholders. Debt ratios include debt-equity ratio and interest coverage ratio. Debt ratios give idea about the leverage of the company. High debt ratios are a cause of concern because they reduce returns for the shareholders since a portion of net income is used to pay interest on the debt. Investment valuation ratios include price earnings ratio and price sales ratio. Investment valuation ratios indicate the price being paid by the shareholders relative to the value of the firm. High price earnings ratio indicates a more optimistic outlook of the organization’s future but they also mean the stock is relatively expensive to purchase.

Financial ratios are useful tools to gauge the performance of the organization but hold little value by themselves. The only reliable way to gauge organization’s performance is to compare its ratios against the competitors as well as change in ratios over time.

…