Financial ratio analysis is a form of quantitative analysis that measures a company’s overall financial health. Several different ratio analyses focus on various aspects of a company’s financial statements. With careful financial statement analysis, it’s possible to see how well a company uses all its potential assets, earnings, and debts to maximize financial performance.
Ratio analysis is an essential tool for analyzing a business’s available documents: the [balance sheet](https://www.masterclass.com/articles/what-is-a-balance-sheet), the <a href='https://masterclass.com/articles/how-to-read-and-understand-an-income-statement' target='_blank' class='mc-text--link' data-mc-segment-trigger='true' data-mc-segment-event-type='Article Page Click' data-event-obj='{"textTag":"p","href":"https://masterclass.com/articles/how-to-read-and-understand-an-income-statement","linkCopy":"income statement","category":"automated-link"}' automatic='true'>income statement</a>, and the statement of cash flows. Internal and external figures (accountants and financial directors would be internal, investors and lenders external) can use ratio analysis to understand how a company is doing on its debt obligations, profitability, and overall financial health.
Ratio analyses are broken down into different categories, depending on the financial information they measure. The categories include:

1. __Liquidity ratios:__ [Liquidity ratios](https://www.masterclass.com/articles/liquidity-ratio-explained) measure a company’s ability to pay its short-term debt. Liquidity ratios include the working capital ratio or [current ratio](https://www.masterclass.com/articles/current-ratio-guide), which subtracts current debt from current assets; the quick ratio, also known as the acid test, which looks at whether the company can pay its current liabilities using accounts receivables; and the [cash ratio](https://www.masterclass.com/articles/cash-ratio-explained), which measures how much a company’s liabilities and short-term obligations are payable using only cash or cash-equivalents.
2. __Efficiency ratios:__ [Efficiency ratios](https://www.masterclass.com/articles/efficiency-ratio-explained) measure a company’s ability to use its assets, meet its liabilities, and make sales to turn a profit. The [inventory turnover ratio](https://www.masterclass.com/articles/inventory-turnover-guide) is a metric that compares the cost of goods sold to the average value of inventory within an accounting period. The fixed asset return ratio compares the use of fixed assets with sales figures, and the total assets turnover ratio compares fixed assets to total assets. These ratios, known as activity ratios or asset management ratios, provide essential data to financial directors and investors essential data.
3. __Solvency ratios:__ [Solvency ratios](https://www.masterclass.com/articles/solvency-ratio-explained), also known as debt management ratios, show how a company is financing its operations with long-term debt versus financing them with equity or retained earnings. Companies can calculate the total debt ratio by dividing the total assets by total liabilities, and can find the [debt-to-equity ratio](https://www.masterclass.com/articles/debt-to-equity-ratio-explained) by dividing the total liabilities by the shareholder's equity.
4. __Profitability ratios:__ Financial directors can calculate [profitability ratios](https://www.masterclass.com/articles/profitability-ratios) in a few ways. One example is to divide net income by sales, giving a figure of profit per dollar or the [net profit margin](https://www.masterclass.com/articles/net-profit-margin-explained). Companies can also divide the net income by total assets to determine the [return on total assets](https://www.masterclass.com/articles/return-on-assets-guide) or ROA. Another method is to divide the [earnings before interest and taxes](https://www.masterclass.com/articles/ebit-explained) (EBIT, sometimes also expanded to earnings before interest, taxes, depreciation, and amortization, or EBITDA) by total assets to get the BEP, or basic earning power ratio. You can also divide the net income by common equity to calculate the return on equity or ROE. Another example of a profitability ratio is [gross profit margin](https://www.masterclass.com/articles/gross-profit-explained) ratio or gross margin, which shows how much profit a company retains after covering costs.
5. __Interest coverage ratios:__ [Interest coverage ratios](https://www.masterclass.com/articles/interest-coverage-ratio) show how well a company can service its debt. Companies can calculate these in two ways: by dividing the EBIT by the interest expense and dividing the net operating income by the total debt service charges, resulting in the debt service coverage ratio, or the DSCR.
6. __Market value ratios:__ The market value ratios, also known as market prospect ratios, are essential for large, publicly traded firms, as they deal with share prices and market valuation in an attempt to determine the financial soundness of a company as an investment. Market value ratios include the P/E ratio or price/earnings ratio, determined by dividing the price per share by earnings per share. Companies calculate the price/cash flow ratio by dividing the stock price by the cash flow per share, and can divide the stock price by the book value per share to get the [market](https://www.masterclass.com/articles/fair-market-value-explained)/book ratio. Market prospect ratios also include dividend yield, dividing dividends per share by stock price per share.
Get the [MasterClass Annual Membership](https://www.masterclass.com) for exclusive access to video lessons taught by business luminaries, including Daniel Pink, Chris Voss, Robin Roberts, Sara Blakely, Bob Iger, Howard Schultz, Anna Wintour, and more.
In the business world, ratio analysis measures the data on a company’s balance sheet. Learn more about the different types of ratio analysis.

In the business world, ratio analysis measures the data on a company’s balance sheet. Learn more about the different types of ratio analysis.

Ratio Analysis: 6 Types of Ratio Analysis

Financial ratio analysis is a form of quantitative analysis that measures a company’s overall financial health. Several different ratio analyses focus on various aspects of a company’s financial statements. With careful financial statement analysis, it’s possible to see how well a company uses all its potential assets, earnings, and debts to maximize financial performance.

What Is Ratio Analysis? 

Ratio analysis is an essential tool for analyzing a business’s available documents: the <a href='https://www.masterclass.com/articles/what-is-a-balance-sheet' target='_self' class='mc-text--link' data-mc-segment-trigger='true' data-mc-segment-event-type='Article Page Click' data-event-obj='{"textTag":"p","href":"https://www.masterclass.com/articles/what-is-a-balance-sheet","linkCopy":"balance sheet","category":null}'>balance sheet</a>, the <a href='https://masterclass.com/articles/how-to-read-and-understand-an-income-statement' target='_blank' class='mc-text--link' data-mc-segment-trigger='true' data-mc-segment-event-type='Article Page Click' data-event-obj='{"textTag":"p","href":"https://masterclass.com/articles/how-to-read-and-understand-an-income-statement","linkCopy":"income statement","category":"automated-link"}' automatic='true'>income statement</a>, and the statement of cash flows. Internal and external figures (accountants and financial directors would be internal, investors and lenders external) can use ratio analysis to understand how a company is doing on its debt obligations, profitability, and overall financial health.

Why Is Ratio Analysis Important? 

Ratio analyses are broken down into different categories, depending on the financial information they measure. The categories include:<ol class="mc-m-4"><li class="mc-my-4"> 1. Liquidity ratios: <a href='https://www.masterclass.com/articles/liquidity-ratio-explained' target='_self' class='mc-text--link' data-mc-segment-trigger='true' data-mc-segment-event-type='Article Page Click' data-event-obj='{"textTag":"p","href":"https://www.masterclass.com/articles/liquidity-ratio-explained","linkCopy":"Liquidity ratios","category":null}'>Liquidity ratios</a> measure a company’s ability to pay its short-term debt. Liquidity ratios include the working capital ratio or <a href='https://www.masterclass.com/articles/current-ratio-guide' target='_self' class='mc-text--link' data-mc-segment-trigger='true' data-mc-segment-event-type='Article Page Click' data-event-obj='{"textTag":"p","href":"https://www.masterclass.com/articles/current-ratio-guide","linkCopy":"current ratio","category":null}'>current ratio</a>, which subtracts current debt from current assets; the quick ratio, also known as the acid test, which looks at whether the company can pay its current liabilities using accounts receivables; and the <a href='https://www.masterclass.com/articles/cash-ratio-explained' target='_self' class='mc-text--link' data-mc-segment-trigger='true' data-mc-segment-event-type='Article Page Click' data-event-obj='{"textTag":"p","href":"https://www.masterclass.com/articles/cash-ratio-explained","linkCopy":"cash ratio","category":null}'>cash ratio</a>, which measures how much a company’s liabilities and short-term obligations are payable using only cash or cash-equivalents. </li><li class="mc-my-4"> 2. Efficiency ratios: <a href='https://www.masterclass.com/articles/efficiency-ratio-explained' target='_self' class='mc-text--link' data-mc-segment-trigger='true' data-mc-segment-event-type='Article Page Click' data-event-obj='{"textTag":"p","href":"https://www.masterclass.com/articles/efficiency-ratio-explained","linkCopy":"Efficiency ratios","category":null}'>Efficiency ratios</a> measure a company’s ability to use its assets, meet its liabilities, and make sales to turn a profit. The <a href='https://www.masterclass.com/articles/inventory-turnover-guide' target='_self' class='mc-text--link' data-mc-segment-trigger='true' data-mc-segment-event-type='Article Page Click' data-event-obj='{"textTag":"p","href":"https://www.masterclass.com/articles/inventory-turnover-guide","linkCopy":"inventory turnover ratio","category":null}'>inventory turnover ratio</a> is a metric that compares the cost of goods sold to the average value of inventory within an accounting period. The fixed asset return ratio compares the use of fixed assets with sales figures, and the total assets turnover ratio compares fixed assets to total assets. These ratios, known as activity ratios or asset management ratios, provide essential data to financial directors and investors essential data. </li><li class="mc-my-4"> 3. Solvency ratios: <a href='https://www.masterclass.com/articles/solvency-ratio-explained' target='_self' class='mc-text--link' data-mc-segment-trigger='true' data-mc-segment-event-type='Article Page Click' data-event-obj='{"textTag":"p","href":"https://www.masterclass.com/articles/solvency-ratio-explained","linkCopy":"Solvency ratios","category":null}'>Solvency ratios</a>, also known as debt management ratios, show how a company is financing its operations with long-term debt versus financing them with equity or retained earnings. Companies can calculate the total debt ratio by dividing the total assets by total liabilities, and can find the <a href='https://www.masterclass.com/articles/debt-to-equity-ratio-explained' target='_self' class='mc-text--link' data-mc-segment-trigger='true' data-mc-segment-event-type='Article Page Click' data-event-obj='{"textTag":"p","href":"https://www.masterclass.com/articles/debt-to-equity-ratio-explained","linkCopy":"debt-to-equity ratio","category":null}'>debt-to-equity ratio</a> by dividing the total liabilities by the shareholder&#39;s equity. </li><li class="mc-my-4"> 4. Profitability ratios: Financial directors can calculate <a href='https://www.masterclass.com/articles/profitability-ratios' target='_self' class='mc-text--link' data-mc-segment-trigger='true' data-mc-segment-event-type='Article Page Click' data-event-obj='{"textTag":"p","href":"https://www.masterclass.com/articles/profitability-ratios","linkCopy":"profitability ratios","category":null}'>profitability ratios</a> in a few ways. One example is to divide net income by sales, giving a figure of profit per dollar or the <a href='https://www.masterclass.com/articles/net-profit-margin-explained' target='_self' class='mc-text--link' data-mc-segment-trigger='true' data-mc-segment-event-type='Article Page Click' data-event-obj='{"textTag":"p","href":"https://www.masterclass.com/articles/net-profit-margin-explained","linkCopy":"net profit margin","category":null}'>net profit margin</a>. Companies can also divide the net income by total assets to determine the <a href='https://www.masterclass.com/articles/return-on-assets-guide' target='_self' class='mc-text--link' data-mc-segment-trigger='true' data-mc-segment-event-type='Article Page Click' data-event-obj='{"textTag":"p","href":"https://www.masterclass.com/articles/return-on-assets-guide","linkCopy":"return on total assets","category":null}'>return on total assets</a> or ROA. Another method is to divide the <a href='https://www.masterclass.com/articles/ebit-explained' target='_self' class='mc-text--link' data-mc-segment-trigger='true' data-mc-segment-event-type='Article Page Click' data-event-obj='{"textTag":"p","href":"https://www.masterclass.com/articles/ebit-explained","linkCopy":"earnings before interest and taxes","category":null}'>earnings before interest and taxes</a> (EBIT, sometimes also expanded to earnings before interest, taxes, depreciation, and amortization, or EBITDA) by total assets to get the BEP, or basic earning power ratio. You can also divide the net income by common equity to calculate the return on equity or ROE. Another example of a profitability ratio is <a href='https://www.masterclass.com/articles/gross-profit-explained' target='_self' class='mc-text--link' data-mc-segment-trigger='true' data-mc-segment-event-type='Article Page Click' data-event-obj='{"textTag":"p","href":"https://www.masterclass.com/articles/gross-profit-explained","linkCopy":"gross profit margin","category":null}'>gross profit margin</a> ratio or gross margin, which shows how much profit a company retains after covering costs. </li><li class="mc-my-4"> 5. Interest coverage ratios: <a href='https://www.masterclass.com/articles/interest-coverage-ratio' target='_self' class='mc-text--link' data-mc-segment-trigger='true' data-mc-segment-event-type='Article Page Click' data-event-obj='{"textTag":"p","href":"https://www.masterclass.com/articles/interest-coverage-ratio","linkCopy":"Interest coverage ratios","category":null}'>Interest coverage ratios</a> show how well a company can service its debt. Companies can calculate these in two ways: by dividing the EBIT by the interest expense and dividing the net operating income by the total debt service charges, resulting in the debt service coverage ratio, or the DSCR. </li><li class="mc-my-4"> 6. Market value ratios: The market value ratios, also known as market prospect ratios, are essential for large, publicly traded firms, as they deal with share prices and market valuation in an attempt to determine the financial soundness of a company as an investment. Market value ratios include the P/E ratio or price/earnings ratio, determined by dividing the price per share by earnings per share. Companies calculate the price/cash flow ratio by dividing the stock price by the cash flow per share, and can divide the stock price by the book value per share to get the <a href='https://www.masterclass.com/articles/fair-market-value-explained' target='_self' class='mc-text--link' data-mc-segment-trigger='true' data-mc-segment-event-type='Article Page Click' data-event-obj='{"textTag":"p","href":"https://www.masterclass.com/articles/fair-market-value-explained","linkCopy":"market","category":null}'>market</a>/book ratio. Market prospect ratios also include dividend yield, dividing dividends per share by stock price per share. </li></ol>

6 Types of Ratio Analysis 

Get the <a href='https://www.masterclass.com' target='_self' class='mc-text--link' data-mc-segment-trigger='true' data-mc-segment-event-type='Article Page Click' data-event-obj='{"textTag":"p","href":"https://www.masterclass.com","linkCopy":"MasterClass Annual Membership","category":null}'>MasterClass Annual Membership</a> for exclusive access to video lessons taught by business luminaries, including Daniel Pink, Chris Voss, Robin Roberts, Sara Blakely, Bob Iger, Howard Schultz, Anna Wintour, and more.

Want to Learn More About Business?

In the business world, ratio analysis measures the data on a company’s balance sheet. Learn more about the different types of ratio analysis.

In the business world, ratio analysis measures the data on a company’s balance sheet. Learn more about the different types of ratio analysis.
