how a key ratio works
key ratios take data from a company s financial statements such as its balance sheet income statement and statement of cash flows and then compare them with other items these numbers are then calculated together to produce a ratio that represents key aspects of the company s financial picture such as liquidity profitability use of debt and earnings strength there are plenty of financial ratios at one s disposal and determining which are key varies according to opinion and popularity some of the most prevalent ratios include not all companies operate in the same way so commonly used ratios tend to vary by industry in other words the ratios applied to best compare technology companies won t be the same as those used to effectively compare banks in the case of the latter it s typical to utilize the capital to assets ratio the loan loss reserves to total loans ratio and the liquidity ratio for tech stocks on the other hand analysts and investors usually prefer to examine price to sales p s ratios return on research capital rorc and so forth example of a key ratiosam is an analyst with xyz research and wants to learn more about abc corp he goes to abc corp s investor relations website and downloads its most recent financial statements sam wants to find out how efficient abc corp is at managing its expenses to generate profits looking at net income sales operating costs accounts payable and net assets figures sam computes some of abc corp s key profitability ratios such as roa and profit margin advantages and disadvantages of a key ratiokey ratios represent a crucial step in determining the financial health of a company as well as whether it is being fairly priced by investors when utilized correctly they can help us to pinpoint each company s strengths and weaknesses and discover how it stacks up against its peers comparisons should be made with companies that are in the same industry and ideally have similar business models 