A balance sheet ratio refers to a financial metric derived by analyzing the components of a balance sheet to assess a company's financial health, stability, and performance. Balance sheet ratios are used by investors, analysts, and lenders to evaluate a company's solvency, liquidity, leverage, profitability, and operational efficiency.
Commonly used balance sheet ratios include the debt-to-equity ratio, current ratio, quick ratio, working capital ratio, and return on equity. The debt-to-equity ratio compares a company's total liabilities to its shareholders' equity, indicating the proportion of debt used to finance operations. The current ratio measures a company's ability to cover its short-term obligations by comparing current assets to current liabilities. The quick ratio, also called the acid-test ratio, assesses a company's immediate liquidity position by excluding inventory from current assets. The working capital ratio compares current assets to current liabilities to evaluate a company's liquidity and short-term financial stability. Return on equity measures a company's profitability by comparing net income to shareholders' equity.
Balance sheet ratios provide insight into a company's financial position, highlighting its ability to meet short-term obligations, manage debt, generate profits, and utilize assets efficiently. These ratios are often compared to industry benchmarks or historical data to assess a company's performance relative to its peers. By analyzing balance sheet ratios, stakeholders can make informed decisions regarding investing, lending, and analyzing the financial health of a company.
