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Financial ratios are essential tools in fundamental analysis, helping investors evaluate a company’s financial health and performance. These ratios provide insights into profitability, liquidity, efficiency, and valuation, aiding in making informed investment decisions.
Profitability Ratios
Profitability ratios measure a company’s ability to generate profit relative to sales, assets, or equity. Common ratios include:
- Gross Profit Margin: Indicates the percentage of revenue that exceeds the cost of goods sold.
- Net Profit Margin: Shows the percentage of revenue remaining after all expenses.
- Return on Assets (ROA): Measures how efficiently a company uses its assets to generate profit.
- Return on Equity (ROE): Reflects the profitability relative to shareholders’ equity.
Liquidity Ratios
Liquidity ratios assess a company’s ability to meet short-term obligations. Key ratios include:
- Current Ratio: Current assets divided by current liabilities.
- Quick Ratio: (Current assets – Inventory) divided by current liabilities.
Efficiency Ratios
Efficiency ratios evaluate how well a company utilizes its assets and manages liabilities. Examples include:
- Asset Turnover: Revenue divided by total assets.
- Inventory Turnover: Cost of goods sold divided by average inventory.
- Receivables Turnover: Net credit sales divided by average accounts receivable.
Valuation Ratios
Valuation ratios help determine a company’s market value relative to its financial metrics. Notable ratios include:
- Price-to-Earnings (P/E) Ratio: Market price per share divided by earnings per share.
- Price-to-Book (P/B) Ratio: Market price per share divided by book value per share.
- Dividend Yield: Annual dividends divided by market price per share.