Educating Investors

Most Important Financial Ratios for every investor3 min read

Financial Ratios can be the biggest tool of an Investor, this can help investors to determine the quality of a business, its efficiency and its profitability. Today we will discuss some important Financial Ratios that every Investor must know before investing in any company, but before this, we would like to give you the 5 categories of Financial Ratios:

  1. Leverage 
  2. Liquidity
  3. Profitability
  4. Operating 
  5. Solvency

All the Financial ratios come under these 5 categories, so now let us discuss the most important financial ratios:

  1. Profit-Earnings (P/E) Ratio: It is the ratio of the Market Value per share and Company’s earnings per share. Earnings per share (EPS) is the amount of a company’s profit allocated to each outstanding share of a company’s common stock, serving as an indicator of the company’s financial health.
  2. Earnings per Share (EPS): It is calculated as a company’s profit divided by the outstanding shares of its common stock. The resulting number serves as an indicator of a company’s profitability. If a company has zero or negative earnings (i.e. a loss) then earnings per share will also be zero or negative.
  3. Return on Equity (ROE): The return on equity (ROE) ratio tells you how much profit the company can earn from your money. This ratio tells us how much money the company earns on an investor’s rupees. The higher the ROE ratio, the higher the profitability.
  4. Working Capital Ratio: Working capital represents a company’s ability to pay its current liabilities with its current assets. Working capital is an important measure of financial health since creditors can measure a company’s ability to pay off its debts within a year.
  5. Quick test ratio: The Quick Test Ratio (also called the Acid Test or Liquidity Ratio) It is the ratio of Current assets minus inventory by current liabilities. It provides a stricter definition of the company’s ability to make payments on current obligations. Ideally, this ratio should be 1:1. If it is higher, the company may keep too much cash on hand or have a poor collection program for accounts receivable. If it is lower, it may indicate that the company relies too heavily on inventory to meet its obligations.
  6. Debt ratio: It is the ratio of Debt and Total Assets. It measures the portion of a company’s capital that is provided by borrowing. A debt ratio greater than 1.0 means the company has a negative net worth and is technically bankrupt. 
  7. Dividend Ratio: The dividend payout ratio is the ratio of the total amount of dividends paid out to shareholders relative to the net income of the company. It is the percentage of earnings paid to shareholders in dividends. 
  8. Dividend Yield: The dividend yield or dividend-price ratio of a share is the dividend per share, divided by the price per share. It is also a company’s total annual dividend payments divided by its market capitalization, assuming the number of shares is constant. 

We are sure that the above ratios would definitely help you to take one step further to your wealth creation journey.


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