How can financial ratios help measure a company's financial performance?

Financial ratios are essential analytical tools for assessing a company's financial health. A common language used by all economic stakeholders, they provide valuable information on an organisation's economic performance and financial stability. So which financial ratios should be analysed? How can the results be interpreted and used to make informed decisions? We explain everything in this article!

The usefulness of ratios in assessing a company's financial health

Financial ratios, derived from the income statement and balance sheet, facilitate comparisons between different companies in the same sector. They are used to identify an organisation's strengths and weaknesses relative to its competitors.

Financial ratios also make it possible to detect financial trends, developments and changes in a company's performance. They are therefore a valuable tool for anticipating potential problems.

Finally, they help investors, creditors and managers make informed decisions and reduce uncertainty. Financial ratios can be used to measure a company's profitability, liquidity and solvency and, consequently, the relevance of its overall strategy.

The various financial ratios used to measure a company's performance

Profitability and return ratios

Profitability ratios measure a company's ability to generate profits in relation to its sales, assets or equity. Among the most commonly used ratios are:

• Net profit margin, which measures the overall profitability of the company.
• Return on equity, which indicates the wealth generated for the owners of the company.
• Return on assets, which provides information on the efficiency with which the company's assets are used to generate profits.

Liquidity ratios

Liquidity ratios assess a company's ability to meet its short-term financial obligations. In other words, they measure a company's ability to meet its debts payable over the coming months.

Solvency (and debt) ratios

Debt ratios assess a company's ability to repay all of its debts.

• The total debt ratio measures the proportion of debt relative to the company's total assets.
• The long-term debt ratio indicates the share of long-term debt in the company's overall financing.

How should a company's financial ratios be interpreted?

To interpret financial ratios correctly, it is necessary to have in-depth knowledge of the company and industry standards.

Here are a few examples to help you understand better:

• High profitability may indicate strong performance, but it is important to compare it with other companies in the same sector in order to put this performance into perspective.
• A low liquidity ratio may signal a lack of cash to meet obligations, but it also reflects the confidence of banks in lending funds to the company.
• A high debt ratio may indicate excessive reliance on borrowing, but the resulting leverage can be attractive to shareholders.

GOOD TO KNOW
Financial ratios must be analysed in the overall context of the company, taking into account its objectives, strategy and competitive environment. Above all, a single ratio cannot be used to assess a company's overall performance.

While financial ratios are valuable tools for measuring a company's performance, they also have their limitations: they only provide a partial view of an organisation's health. They are based on historical financial data and may therefore not accurately reflect the organisation's current or future situation. They must therefore be interpreted with care and used in conjunction with other strategic information about the company. This blog article is an introduction to the subject. If you would like to learn more, discover our finance training courses: