Financial ratios are valuable investment tools for providing an investor a sharper picture of a company he wants to understand. Ratios are divided into four categories — liquidity ratios, operating ratios, solvency ratios, and valuation ratios — as shown in the following table.
| Ratio | Formula | Use |
|---|---|---|
| Liquidity Ratios | ||
| Current ratio | Total current assets ÷ total current liabilities | Gives some indication whether a company has enough financial cushion to meet its near-term obligations. |
| Quick ratio | (Current assets less inventory) ÷ current liabilities | Same as current ratio, without including inventory in the calculation. Provides another sign of a company’s strength or weakness. |
| Operating Ratios | ||
| Return on equity (ROE) | Net earnings ÷ owners’ equity | Measures how well the company is managing its resources. |
| Return on assets (ROA) | Net earnings ÷ total assets | Reflects the relationship between a company’s profit and the assets used to generate it. |
| Solvency Ratios | ||
| Debt to equity | Total debt ÷ owners’ equity | Indicates how dependent a company is on debt. |
| Debt to assets (or “debt ratio”) | Total debt ÷ total assets | The higher the ratio, the more financial risk the company has assumed. |
| Valuation Ratios | ||
| Price-to-earnings (P/E) | Stock price per share ÷ net earnings per share | Clues you in to how much you are paying for the company’s earnings. |
| Price-to-book (P/B) | Stock price (total market cap) ÷ book value | Compares the company’s market value to its accounting (or book) value. |
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Source:http://www.dummies.com/how-to/content/key-financial-ratios-in-highpowered-investing.html
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