What is a financial ratio used for?

A financial ratio is a tool that helps evaluate a company's performance by establishing a quantitative relationship between various financial metrics. It allows stakeholders, such as investors and analysts, to assess the efficiency, profitability, liquidity, and solvency of a business at a glance. By expressing one financial measure in relation to another, these ratios can provide valuable insights into operational performance and facilitate comparisons across different companies or time periods.

For instance, commonly used financial ratios include the current ratio, which measures liquidity, and the return on equity, which evaluates profitability. These ratios help in making informed business decisions, understanding financial health, and identifying strengths or weaknesses.

In contrast, determining market trends involves broader analyses beyond just financial ratios, while setting stock prices relies on a multitude of factors, including market perception and demand. Predicting future earnings is more complex and requires additional forecasting methods and assumptions, which go beyond the insights offered by financial ratios alone.