Lesson 46 - Beginner accounting course

46. Introduction to Financial Ratios: Why They Matter

Financial ratios are essential tools for analyzing a company’s financial health. They help business owners, investors, and analysts make informed decisions by evaluating profitability, liquidity, efficiency, and financial stability. Ratios simplify complex financial data, allowing easy comparison between companies or tracking performance over time.

1. What Are Financial Ratios?

Financial ratios are mathematical comparisons derived from financial statements. They provide insights into different aspects of a company’s performance, such as:

• Liquidity – Can the company pay its short-term debts?

• Profitability – Is the company generating enough profit?

• Efficiency – How well is the company using its resources?

• Leverage – How much debt does the company have?

These ratios allow businesses to:
- Identify strengths and weaknesses
- Compare performance with industry benchmarks
- Make informed financial and investment decisions

2. Types of Financial Ratios

Financial ratios fall into four main categories:

3. Why Are Financial Ratios Important?

• Investors and Lenders – Use ratios to assess a company’s financial strength before investing or lending money.

• Business Owners and Managers – Use ratios to track financial health and make strategic decisions.

• Competitors and Market Analysts – Compare financial performance with industry benchmarks.

By understanding and using financial ratios, companies can improve decision-making, manage risks, and ensure long-term success.