Ratio Analysis Tutorial

Fundamental analysis is an analytical method investors use to value companies based on a study of corporate profitability and financial measures. One way to do this is to look at the general, qualitative factors of a company – for example what industry or sector the company is in, who are their competitors, and if they have a recognizable brand name. Another approach to fundamental analysis considers tangible and measurable quantitative factors. This means, for instance, crunching the numbers and closely analyzing financial statements such as the balance sheet and income statement. When used in conjunction with other methods, quantitative analysis can produce excellent results and give patient investors an edge over time.

Ratio analysis is one way to make sense of these corporate data. Looking at ratios is more involved than simply comparing different figures from the balance sheet, income statement and cash flow statement. It requires relating these calculated ratios against previous years, other companies, the industry the company is in, and even the economy at large. Ratios can give you a glimpse into the relationships among and between individual values that relate to a company’s operations and link them to how a company has performed in the past, and how it might perform in the future. The result is a potentially robust method of valuing the shares of a company.

For example, a piece of data such as current assets, which appears on the balance sheet, cannot by itself tell us a whole lot – but when we divide current assets by current liabilities we get important information about a company – namely, whether it has enough money to cover short-term debts. Then, compare one company’s assets-to-debts with another in the same industry to determine if one is on more stable financial footing than the other. We can also compare that figure against the industry average to see if a stock may outperform its peers.

In this tutorial, we'll show you how to use ratio analysis to analyze a company’s financial reports and go over a number of commonly used and helpful ratios. This tutorial intends to shed some light on how this process can be done and, ultimately, help you to make more informed decisions as an investor.