Financial ratios turn raw numbers from financial statements into meaningful, comparable metrics. Saying a company earned $500 million tells you little — but an ROE of 25%, a P/E of 15, and a debt-to-equity of 0.5 tells you it is profitable, reasonably valued, and conservatively financed. Ratios make apples-to-apples comparison possible.
Five categories: profitability ratios (ROE, ROA, profit margin); liquidity ratios (current ratio, quick ratio); leverage ratios (debt-to-equity, ICR); efficiency ratios (inventory turnover, asset turnover); and valuation ratios (P/E, P/B, EV/EBITDA). Together, they paint a complete picture of a company's financial health.
The key: never look at a ratio in isolation. Compare it against the company's own history (trend analysis), its industry peers (peer comparison), and industry benchmarks. A current ratio of 1.2 might be poor for a manufacturer but excellent for a supermarket chain. Context determines whether a ratio is good or bad.