Contact Us!

How to Interpret 6 Basic Financial Ratios

To determine the real value of a company, you must thoroughly examine financial data. An analysis of the profit and loss account, balance sheet, and cash flow statement of a company is usually performed. The process can take a long time and be inconvenient. To learn about a company’s performance, you can examine its financial ratios, most of which are freely available on the internet.  Although this is not the best strategy, it is a quick way to assess the health of a company.

1-Working Capital Ratio

Working capital is the ability of a business to pay its current liabilities with its current assets. Since creditors can assess a company’s ability to pay off its debts within a year, working capital is an essential indicator of financial health.

Working capital is the difference between a company’s current assets and current liabilities. It can be challenging to find the right category for the diversity of assets and obligations on a balance sheet, as well as to determine a firm’s overall ability to pay its short-term obligations.

Liquidity is an important factor to determine the health of a company you wish to invest in. The liquidity of a company refers to its ability to convert assets into cash to meet short-term obligations. To calculate the working capital ratio, divide assets by liabilities.

2-Quick Ratio

In the acid test, inventories are subtracted from current assets before the result is divided by liabilities. Cash and items with a ready cash value should be compared with current liabilities to show how well they cover them. In contrast, inventory can take a long time to sell and convert into cash.

3-Earnings per Share (EPS)

Stocks represent an investment in the future earnings (or loss) of the company. The earnings per share (EPS) of a company’s common stock measures its net income. Analysts divide the company’s net income by the weighted average number of common shares outstanding throughout the year.

If a company has zero or negative earnings (losses), earnings per share will be zero or negative.

4-Price-Earnings (P/E) Ratio

P/E represents investors’ expectations for future earnings. A P/E ratio is calculated by dividing the company’s share price by its earnings per share.

When a company has zero or negative earnings, the P/E ratio no longer makes sense and will commonly appear as N/A.

Nevertheless, investors have been prepared to pay more than 20 times earnings per share if they think future earnings growth will provide a sufficient return on investment.

5-Debt-Equity Ratio

Can you make an investment if your target borrows excessively? In turn, this might reduce the safety margins behind what it owes, increase fixed expenses, reduce earnings available for dividends, and eventually trigger a financial crisis.

The debt-to-equity ratio (D/E) is calculated by multiplying long- and short-term debt by shareholders’ equity book value.

6-Return on Equity (ROE)

It is important for shareholders to know how profitable the companies in which they invest are. To compute return on equity, a company’s net earnings (after taxes) are subtracted from preferred dividends, and the result is divided by its common equity.


Gradually becoming wealthy may lose some of its romance by applying equations. As a result, the above ratios can aid you in selecting the best stocks for your portfolio, increasing your wealth while having a good time. Financial measures are used in fundamental analysis in dozens of ways, and we’ve covered just six of the most popular ones. The full potential of a firm cannot be gauged with just one ratio; it must be assessed using a combination of ratios and metrics.

error: Content is protected !!