1/10/2017 RatioAnalysisDefinition|Investopedia

Topics Reference Simulator

Search Investopedia Newsletters
Chennai to Hyderabad on Chennai to Hyderabad on
Advisorto Insights
Hyderabad Chennai on 1 Chennai to Hyderabad on
Book Now Book Now
1,450
Book Now Book Now

Ratio Analysis
You May Also Like: Learn to trade stocks with virtual money before you risk your own...

What is 'Ratio Analysis'

A ratio analysis is a quantitative analysis of information contained in a
companys financial statements. Ratio analysis is based on line items in
financial statements like the balance sheet,sheet, income statement and cash flow
statement; the ratios of one item or a combination of items - to another
item or combination are then calculated. Ratio analysis is used to evaluate
various aspects of a companys operating and financial performance such as
its efficiency, liquidity
liquidity,, profitability and solvency
solvency.. The trend of these ratios
over time is studied to check whether they are improving or deteriorating.
Ratios are also compared across different companies in the same sector to
see how they stack up, and to get an idea of comparative valuations
valuations.. Ratio
analysis is a cornerstone of fundamental analysis.
analysis.
00:01 02:24

BREAKING DOWN 'Ratio Analysis'

While there are numerous financial ratios, most investors are familiar with a few key ratios,
ratios,
particularly the ones that are relatively easy to calculate. Some of these ratios include the current
ratio,, return on equity,
ratio equity, the debt-equity ratio, the dividend payout ratio and the price/earnings (P/E)
ratio.

For a specific ratio, most companies have values that fall within a certain range. A company whose
ratio falls outside the range may be regarded as grossly undervalued or overvalued, depending on
the ratio.

For example, if the average P/E ratio of all companies in the S&P 500 index is 20, with the majority of
companies having a P/E between 15 and 25, a stock with a single-digit P/E would be considered
undervalued, while one with a P/E of 50 would be considered overvalued. Of course, this ratio would
Trading Center
typically only be considered as a starting point, with further analysis required to identify if these
stocks are really as undervalued or overvalued as the P/E ratios suggest.

As well, ratios are usually only comparable across companies in the same sector, since an acceptable
ratio in one industry may be regarded as too high in another. For example, companies in sectors
such as utilities typically have a high debt-equity ratio, but a similar ratio for a technology company
may be regarded as unsustainably high.

Ratio analysis can provide an early warning of a potential improvement or deterioration in a

companys financial situation or performance. Analysts engage in extensive number-crunching of
the financial data in a companys quarterly financial reports for any such hints.

Successful companies generally have solid ratios in all areas, and any hints of weakness in one area
may spark a significant sell-off in the stock. Certain ratios are closely scrutinized because of their
relevance to a certain sector, as for instance inventory turnover for the retail sector and days sales
outstanding (DSOs) for technology companies.

http://www.investopedia.com/terms/r/ratioanalysis.asp 1/3
1/10/2017 RatioAnalysisDefinition|Investopedia

Test Your Skills With Trading Challenges

Topics Reference Simulator
Put your trading skills to the test with our free Stock Simulator. The ideal platform to get your
Search Investopedia Newsletters
financial feet wet! Submit trades in a virtual environment before you start risking your own capital.
Advisor Insights
Click here to sign up today and start interacting with other traders from diverse backgrounds and
experiences, and learn the methods behind their trades to become a better investor.

Current Ratio

Video Definition

Loading the player...

The current ratio is a liquidity ratio that measures a company's ability to pay short-term and long-
term obligations. To gauge this ability, the current ratio considers the current total assets of a
company (both liquid and illiquid
illiquid)) relative to that companys current total liabilities
liabilities..

The formula for calculating a companys current ratio, then, is:

Current Ratio = Current Assets / Current Liabilities

The current ratio is called current because, unlike some other liquidity ratios, it incorporates all
current assets and liabilities.

The current ratio is also known as the working capital ratio.

BREAKING DOWN 'Current Ratio'

The current ratio is mainly used to give an idea of the company's ability to pay back its liabilities
(debt and accounts payable)
payable) with its assets (cash
(cash,, marketable securities
securities,, inventory
inventory,, accounts
receivable).
receivable ). As such, current ratio can be used to take a rough measurement of a companys financial
health.. The higher the current ratio, the more capable the company is of paying its obligations
health obligations,, as it
has a larger proportion of asset value relative to the value of its liabilities.

Read More +
http://www.investopedia.com/terms/r/ratioanalysis.asp 2/3
1/10/2017 RatioAnalysisDefinition|Investopedia

Topics Reference Simulator

Search Investopedia Newsletters
Advisor Insights

Search Investopedia Symbol

DICTIONARY: # A B C D E F G H I J K L M N O P Q R S T U V W X

CONTENT LIBRARY CONNECT WITH INVESTOPED

Articles Terms
Stock Simulator
Videos
FXtrader
Guides Slideshows
Exam Prep Quizzer
FAQs Calculators
Net Worth Calculator
Chart Advisor Stock Analysis
HcrI
WORK WITH INVESTOPEDIA GET FREE NEWSLETTE
About Us Advertise With Us Write For Us Contact Us Careers Newsletters

2017, Investopedia, LLC. All Rights Reserved Terms Of Use Privacy Policy

http://www.investopedia.com/terms/r/ratioanalysis.asp 3/3