Key Ratio Definition & Examples

KEY TAKEAWAYS

• Key ratios get used to summarize a company’s financial condition. 
• Information from a company’s financial statements gets used to process the data. These can include income statements, statements of cash flows, and balance sheets. 
• Investors and analysts benefit from using key ratios to find out how a specific company compares with another. 

What Is a Key Ratio?

To put it simply, a key ratio relates to any type of financial ratio used to look into areas of your business. They’re effective at doing everything from illustrating, measuring, and summarizing. And it’s done to compare the financials of your business compared to your competition. 

Many companies and investors use key ratios to dive deep into what makes a business tick. For example, they can provide an overview of things such as efficiency, liquidity, and profitability. 

It’s important to understand that each key ratio is going to focus on a specific element of a company. This means that to get a complete snapshot, it’s necessary to look into multiple key ratios. 

When a company is in good financial health, its key ratios are typically going to be much higher. And a company that isn’t performing particularly well will likely have lower ratios. 

How Does a Key Ratio Work?

Every company is going to have certain kinds of financial statements. These can include things like a statement of cash flows, a balance sheet, and an income statement. A key ratio retrieves the data from these statements and then compares them with others. 

Then, the numbers get calculated to come up with a ratio that’s going to relate to certain areas of a company’s health. For example, an investor might want to get a better sense of profitability or liquidity. Key ratios are also good to learn more about the use of debt or potential earnings strength. 

What Are the Primary Key Ratios?

Depending on what you’re looking for, there are any number of financial ratios you could look into. That said, there is a handful that get used more often than others. These include:

• Return on assets ratio
• Working capital ratio
• Price-earnings ratio
• Return on equity ratio
• Return on investment ratio
• Liquidity ratios
• Debt to equity ratio
• Debt to asset ratio

Key Ratio Example 

Let’s say that an investor wants to learn more about your company. They’d start by getting access to your most recent financial statement. Here, they can gain insights from your balance sheet assets, income statement, and accounting practices. 

Then, the investor can dive deeper, finding out how your company generates profits and how you manage your expenses. They can use key profitability ratios like profit margin and return on assets. All of this information would come from looking at things like accounts payable, net income, sales, and operating expenses.

The investor can gain insights from other areas such as net assets figures and the operating costs of your company. Plus, they’ll have a better sense of things like current liabilities, cash flow, and stock price if you have one. 

Summary 

A key ratio gets used to observe the financial condition of a particular company. They’re primary financial ratios that get produced by comparing line items from financial statements. Basically, it’s an analysis of financial statements and it can be used by several business models.

It’s an effective way for an investor or analyst to get a better sense of how one business compares with another. They’re a fundamental analysis used to determine the overall financial health of a company. Plus, a key ratio gives a complete picture of core business operations, such as operational efficiency.

When a key ratio is used properly it can give an overview of the biggest strengths and weaknesses. That said, one key ratio typically isn’t enough to provide a deep enough snapshot. Putting together multiple key ratios is the most effective way to get a true overview of a company’s financial performance.