What are Corporate Finance Ratios?
Corporate Finance Ratios are quantitative measures that are used to assess businesses. These ratios are used by financial analysts, equity research analysts, investors, and asset managers to evaluate the overall financial health of businesses, with the end goal of making better investment decisions. Corporate Finance Ratios are also heavily used by financial managers and C-suite officers to get a better understanding of how their business is performing.
Types of Corporate Finance Ratios
Corporate Finance Ratios can be broken down into four categories that measure different types of financial metrics for a business: Liquidity ratios, Operational Risk ratios, Profitability ratios, and Efficiency Ratios. The differences between these categories are explained in the following graphic:
How to Use Ratios?
Corporate Finance Ratios enable analysts, management, and investors to assess the financial performance of a company by ranking them against time-series data, competitor ratios, or performance targets.
Ratios are not very meaningful by themselves. To draw better insights from them, we should calculate the same ratios for a number of different companies that operate within the same industry (i.e., competitors). This will enable us to better understand how well a company is performing within the context of the industry. Ratios can also be computed at various periods in time in order to see how they have evolved over time. This can be done for an individual company, or for a number of companies operating in the same industry in order to observe how specific metrics have changed.
Lastly, ratios can be used to benchmark the performance of a company’s management team against targets that were set out earlier. Some companies compensate their management teams when certain specific ratio targets are achieved. For example, a CEO may receive a special bonus if, under his tenure, the company is able to increase its return on equity by 10%.