Financial ratios help you summarize a company’s performance using numbers.
They don’t tell the full story, but they highlight strengths and weaknesses quickly.
This lesson focuses on understanding concepts, not memorising formulas.
Why Financial Ratios Matter
- Convert financial statements into comparable insights
- Help compare companies within the same industry
- Highlight efficiency, profitability, and risk
- Act as warning signals, not final decisions
📌 Think of ratios as health indicators, not verdicts.
Key Ratios Every Beginner Should Know
1️⃣ Return on Equity (ROE)
- Measures how efficiently a company uses shareholders’ money
- Higher ROE usually indicates better capital usage
📌 High ROE is meaningful only if debt is under control.
2️⃣ Return on Capital Employed (ROCE)
- Shows how efficiently total capital (equity + debt) is used
- Useful for comparing capital-intensive businesses
📌 Consistent ROCE > cost of capital is a good sign.
3️⃣ Debt-to-Equity Ratio
- Indicates how much debt a company uses vs its own capital
- Lower ratio generally means lower financial risk
📌 High debt can magnify profits — and losses.
4️⃣ Profit Margins
- Operating Margin
- Net Profit Margin
Shows how much profit remains from revenue.
📌 Stable or improving margins signal pricing power and efficiency.
5️⃣ Growth Indicators
- Revenue growth
- Profit growth
- Cash flow growth
📌 Growth should be consistent and sustainable, not one-time.
Common Beginner Mistakes with Ratios
- Looking at one ratio in isolation
- Comparing across different industries
- Ignoring trends over time
- Treating ratios as buy/sell signals
Key Takeaway
Ratios support your analysis, they don’t replace thinking.
📌 Ratios are tools — not decisions by themselves.
👉 Next: Lesson 9 – Valuation Basics (Simple Approach)