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The ratios provide investors with an idea of the overall operational performance of a firm.
As with all types of fundamental analysis, it is often most useful to compare the financial ratios of a firm to those of other companies. For the purpose of this analysis, the commonly used ratios are grouped into four categories: activity, liquidity, solvency and profitability.
Also, for the sake of consistency, the data in the financial statements created for the prior installments of the Financial Statement Analysis series will be used to illustrate the ratios.
Table 1 shows the formulas with examples for each of the ratios discussed.
Activity ratios are used to measure how efficiently a company utilizes its assets.
In our example in Table 1, the inventory turnover ratio of 2.6x means that inventory was “turned over” or replenished 2.6 times during a period of one year.