Financial Ratios Explained

Hello, I am Umesh Tripathi, and we are learning the concepts of Fundamental Analysis. In this video, we are going to learn about Financial Ratios. Here we will understand what Financial Ratios are, discuss some profitability-related ratios, some liquidity-related ratios, and we will also discuss debt ratios and efficiency ratios. 

So basically, when we talk about Financial Ratios, Financial Ratios are numbers that are derived from Financial Statements. In the previous videos, we have seen what Financial Statements are, how we read the Balance Sheet, how we read Profitability-related statements, and how we read Cash Flow Statements. 

Financial Ratios are actually numbers derived using these Financial Statements, and they basically help us figure out the company’s overall health in terms of financial performance and efficiency. Studying these Financial Ratios tells us about the company’s current financial status and also helps us identify long-term trends. These not only help long-term investors make long-term investment decisions but also help management in making strategic business decisions. 

Additionally, Financial Ratios are needed for industry and peer comparison. Because whenever we compare a certain company with its industry, whether profitability ratios or liquidity ratios, it becomes easier for us to evaluate performance. 

Now let’s discuss some profitability ratios. These are financial metrics that measure a company’s ability to generate profits relative to its revenues, assets, and equity. 

• Return on Equity (ROE): ROE is a kind of profitability metric. It measures the return on shareholders’ investment. The formula for ROE is simple and clear: ROE = Net Income ÷ Shareholders’ Equity × 100. This gives us a percentage. The higher the ROE, the stronger the profitability of the company. 

• Return on Capital Employed (ROCE): ROCE is another profitability metric. It measures the return on all the capital employed in the company. The formula is EBIT ÷ Capital Employed × 100, where EBIT is Earnings Before Interest and Taxes. ROCE actually tells us the efficiency of using capital to generate operating profits. 

• Return on Assets (ROA): ROA is also a profitability metric. It tells us how the company is using its assets to generate earnings. The formula is Net Income ÷ Total Assets × 100. It measures how efficiently a company uses its assets to generate profits. 

Now let’s talk about liquidity ratios. What is liquidity? We have already learned this in previous videos. Basically, the records of receivables and payables are reflected in the financial statements and can be seen in the Balance Sheet. Using the company’s assets and liabilities, we can calculate the current ratio. 

• Current Ratio: Current Ratio = Current Assets ÷ Current Liabilities. If the Current Ratio is greater than 1, it indicates that assets exceed liabilities. At any given point in time, Current Assets should be greater than Current Liabilities. That is when the ratio is more than 1, and we can clearly understand that the company has more assets than its liabilities. 

• Quick Ratio: In Quick Ratio, we also consider current assets but subtract inventories from current assets, then divide by current liabilities. Quick Ratio = (Current Assets – Inventories) ÷ Current Liabilities. This provides a stricter test of liquidity, excluding inventory, which is the least liquid current asset. 

Next, let’s talk about debt-related ratios. Here we figure out whether the company can repay its debts in the future or not. 

• Debt-to-Equity Ratio: Debt-to-Equity = Total Debt ÷ Shareholders’ Equity. It shows the proportion of debt used to finance the company relative to equity. The higher the debt, the higher the financial risk. 

Now let’s look at efficiency ratios. Efficiency Ratios measure how well a company uses its assets to manage overall operations. 

• Asset Turnover Ratio: This measures how effectively a company uses its assets to generate revenues. Asset Turnover Ratio = Net Sales ÷ Average Total Assets. 

• Inventory Turnover Ratio: This reflects how frequently inventory is sold and replaced over a period of time. Inventory Turnover Ratio = Cost of Goods Sold ÷ Average Inventory. This shows how often inventory is sold or replaced in a given period. 

There are various platforms where these ratios can be viewed. For example, on the m.Stock platform, most ratios such as ROCE, ROE, and Earnings Per Share are available. 

In this example, for a certain company: 

• ROCE in March 2024 was around 9.38%. 

• ROE in March 2024 was around 8.16%. 

• ROCE in March 2025 decreased to about 7.47%. 

• ROE in March 2025 decreased to around 6.49%. 

From this, we see that the return on equity generated by the company in 2024 has slightly declined in 2025, indicating some difficulty in generating returns on equity compared to the previous year. 

So, basically, Financial Ratios provide key insights into the company’s overall financial standing. They give a clear idea of whether the company is financially strong or not. They are essential for decision-making by investors, management, and even lenders. Using Financial Ratios, they assess the company’s current performance, scope for growth, and compare how the company is performing versus the previous year. Regular ratio analysis helps track the changes happening in the overall financial performance. 

In this video, we learned in detail about Financial Ratios. That’s all for this video. See you in the next one. 

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