Financial ratios are part of the broader topic financial statement analysis. Since most of the financial ratios are calculated from amounts reported on recent financial statements, they are historic in nature.
The following financial ratios are calculated by using amounts reported on the balance sheet:
The first three ratios are indicators of a corporation's liquidity. The latter two ratios are indicators of a corporation's degree of leverage.
The following financial ratios use amounts from both the balance sheet and the income statement:
For example, the inventory turnover ratio is calculated by dividing the cost of goods sold (from the income statement) by the average inventory amounts that are found on the balance sheets.
Examples of financial ratios that use amounts only from the income statement include:
These financial ratios are indicators of a company's profitability.
In addition to financial ratios, another tool in financial statement analysis is common-size financial statements. A common-size balance sheet results when every amount on the balance sheet is divided by the amount of total assets. A common-size income statement is the result of dividing each item on the income statement by the amount of net sales. Common-size financial statements allow for a comparison between companies of any size and also with industry averages. For example, a corporation's common-size balance sheet might indicate that its current assets are 40% of its total assets. That percentage can then be compared to a competitor's percentage and to the percentage for its industry.
If a corporation's stock is publicly traded, the Management Discussion section of its annual report to the Securities and Exchange Commission Form 10-K provides helpful information behind the financial ratios.
Featured Review
"I am currently a staff accountant. I just LOVE AccountingCoach because not only did it help me get into the accounting industry, but it helped me get the job I have today. I am now retired, and my background was in human resources, but I wanted to get into accounting. I didn't want to go to college before seeing if I would like it, so I started to apply for jobs in accounting and quickly saw that it required a degree. I researched for a creative way to get into the industry and came across AccountingCoach online. I decided to give it a try because I wanted to get some skills, and thank goodness I did! I went through the modules, which taught me the basic skills of accounting. I took the quizzes and used all the resources, and it helped so much. I did this for 6 months before I started applying for accounting jobs and landed my first accounting position in accounts payable. From there, I continued to progress using AccountingCoach to assist me along the way and have worked my way up to the position of Staff Accountant. I have now been in the industry for over 5 years, and I love it. AccountingCoach is the best resource out to get your foot in the door and to progress in your position." - Michelle M.
Join PRO or PRO Plus and Get Lifetime Access to Our Premium Materials
Read all 2,645 reviewsWe now offer 10 Certificates of Achievement for Introductory Accounting and Bookkeeping: