Interpreting ratios

Investors and other external interest groups of a company usually only have access to the financial statements of a company. However, the financials on their own are of limited use when trying to assess a company. Ratios are a valuable tool for such interest groups, giving them the opportunity to assess companies in a standardized manner using widely accepted parameters.

It is usually very subjective to try and compare companies of different sizes, geographical locations, fiscal jurisdictions, and nature. Ratio analysis provides a level playing field by placing emphasis on performance rather than the absolute size of turnover or profit. Efficiency, profitability, and liquidity are more or less independent of the absolute size of the individual parameters involved, such as turnover, assets, profit, and liabilities.

Ratio analysis allows the comparison of diverse companies, and also allows analysts to set benchmarks for the different ratios so that upcoming...