Financial ratio analysis is a method of comparing businesses across a similar set of evaluation criteria. By using a particular financial ratio (such as a profitability ratio), then businesses of different sizes can be compared on a similar basis regardless of the disparity in size (no matter how size is measured) because the ratio analysis takes the magnitude of dollars out of the picture. Financial ratio analysis is a method of categorizing basic financial information into more meaningful values relevant to various aspects of the business.
Typically the categories of ratio analysis include liquidity ratios which provide an assessment of current resources available for ongoing operations; leverage ratios which provide insight into the utilization of debt in the business structure; activities ratios which tend to reflect the efficient utilization of resources for operations; and profitability ratios which indicate the overall effectiveness of management of the firm.
