Financial Ratios
Contents
Definition
Financial Ratios are derived measures (ratios) capturing the economic and financial condition of an entity starting from more primary financial inputs (e.g. from Financial Statements, balance sheets or other formal representations).
Motivation
The key desired objective and benefit of using a ratio instead of the underlying absolute measurements, values or metrics is to obtain a scale independent metric. That means an indicator that does not depend explicitly on the size of an entity (where size can be any relevant indicator such as turnover, number of employees etc). This allows for sharper insights into the state of an entity and its profile in relation to peers.
Usage
Ratios are used widely in financial analysis of companies, valuations, also in the Risk Analysis of Credit Risk and the assignemt of a Credit Rating.
Types
- Capital ratios capturing an entity's Capital Structure and in particular Leverage
- Liquidity ratios capturing an entity's Liquidity profile
- Profitability ratios
- Activity ratios
- Sustainability ratios (such as the Green Asset Ratio)
List of Financial Ratios
- Debt Service Coverage Ratio (DSCR)
- Loan Life Coverage Ratio (LLCR)
- Project Life Coverage Ratio (PLCR)
- Debt To Equity Ratio
- Loan To Value Ratio (LTV)
Issues and Challenges
- Being based solely on financial statements, ratios are subject to all issues that can affect the completeness, credibility, consistency and comparability of such figures
- Different ratios can be highly correlated
