A financial ratio is a relationship between particular groups of assets or liabilities of an enterprise and corresponding totals of assets or liabilities, or between assets or liabilities and flows like turnover or revenue.
A leading example is the price/earnings ratio which is the ratio of the current quoted stock exchange price of an equity to the most recent declared dividend per share.
Another is the ratio of equity to debt finance (gearing ratio) within a company's overall capital structure.
Financial ratios are used to give summary indications of the financial performance, prospects or strength of a company which help financial managers to make a comparison of a firm's financial condition over time or in relation to other firms.
No single financial ratio can answer all questions analysts may have.
In fact, five different groups of ratios have been developed:
a) liquidity ratios indicating a firm's ability to meet short-term financial obligations;
b) activity ratios indicating how efficiently a firm is using its assets to generate sales;
e) financial leverage ratios indicating a firm's capacity to meet short- and long-term debt obligations;
d) profitability ratios measuring how effectively a firm's management generates profits on sales, assets, and stockholders' investments;
e) market-based ratios measuring the financial market's evaluation of a company's stock.