What is the primary purpose of financial ratios?

The primary purpose of financial ratios is to evaluate a company's performance and financial health. Financial ratios provide a quantitative analysis that enables stakeholders—including investors, creditors, and management—to assess various aspects of a company's financial situation, such as liquidity, profitability, efficiency, and leverage. By comparing these ratios over time or against industry benchmarks, stakeholders can gain insights into how well the company is doing in relation to its peers and its historical performance.

For instance, a higher current ratio might indicate better short-term financial health, while a higher return on equity suggests that the company is effectively generating profits relative to shareholder equity. These evaluations are crucial for making informed decisions regarding investments, lending, and strategic planning.