What is a financial ratio used for?

The purpose of a financial ratio is primarily to evaluate the financial status or performance of a company. Financial ratios are analytical tools that help stakeholders, such as investors, creditors, and management, assess a company’s profitability, liquidity, efficiency, and solvency. By comparing various financial figures from the company's financial statements, ratios provide a clearer picture of how well the company is performing and its financial health compared to industry benchmarks or historical performance.

Understanding financial ratios is crucial for making informed business decisions, as they distill complex financial information into understandable metrics. They can indicate how well a company is managing its resources or how effectively it is using its capital and assets to generate earnings. Various ratios serve distinct purposes, such as the current ratio for liquidity assessment, the debt-to-equity ratio for understanding leverage, and return on equity (ROE) for profitability analysis. These insights help in strategic planning, operational adjustments, and investment evaluations.