# What is Ratio Analysis?

## Ratio Analysis

Ratio analysis is a technique used in financial analysis to gain insight into a company’s liquidity, operational efficiency, profitability, and solvency by examining and comparing specific figures from its financial statements. These ratios can be used to track a company’s performance over time and to compare its performance to that of other companies in the same industry.

Here are some key types of financial ratios and their uses:

## Example of Ratio Analysis

Let’s use a hypothetical example to illustrate ratio analysis for two competing tech companies, TechA and TechB.

Financial Data (in USD):

Ratio Calculations:

• Current Ratio:
• TechA: 1,000,000 / 500,000 = 2.0
• TechB: 800,000 / 600,000 = 1.33
• Net Profit Margin:
• TechA: 300,000 / 2,000,000 = 0.15 or 15%
• TechB: 250,000 / 1,800,000 = 0.138 or 13.8%
• Return on Equity (ROE):
• TechA: 300,000 / 1,500,000 = 0.20 or 20%
• TechB: 250,000 / 1,000,000 = 0.25 or 25%
• Price-to-Earnings Ratio (P/E):
• TechA: 50 / 3 = 16.67
• TechB: 40 / 2.5 = 16

Interpretation:

• Liquidity : TechA has a higher current ratio (2.0 vs. 1.33), suggesting it’s better positioned to meet short-term obligations using its current assets.
• Profitability : TechA has a slightly higher net profit margin, meaning it’s slightly more efficient at turning revenue into profit. However, TechB has a higher ROE, indicating it provides a higher return on the equity invested by shareholders.
• Market Valuation v: Both companies have fairly similar P/E ratios, implying the market values their earnings somewhat equally, but TechA has a slightly higher P/E ratio, which could suggest that investors expect higher growth or see slightly more value in TechA.

This simplified example showcases how ratio analysis can be used to compare the financial performance and position of two companies. When used in real-world scenarios, analysts would consider a much broader range of ratios, alongside other qualitative and quantitative factors, before drawing conclusions or making investment decisions.