Introduction to financial health ratios

Before reading this lesson, you should have read through:

Now that you have learned what information a financial statement contains, this lesson will show you how you can use this information to analyse a company.

There are three main types of ratios that you can calculate: financial health ratios, performance ratios and valuation ratios. This lesson will first introduce you to financial health ratios and the following lessons will show you how you can use them.

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Financial health ratios will help you determine a company's strength and resilience

Financial health ratios help you determine how strong a company is and what are the risks of it going bankrupt. They also give you an idea of how efficient a company is at managing its costs and investing its assets.

By looking at factors such as how easily a company can pay off its debts, meet its interest payment obligations and pay its suppliers, you get an idea of how at risk of bankruptcy it is.

For a shares investor, bankruptcy is a worst-case-scenario, which could see the shares you have bought lose all of their value.

By looking at things like a company's profit margin and its operating cash flow/sales ratio, you get an understanding of how efficient its management is at containing costs and turning sales into hard cash that the company can then invest in the business or pay out as dividends.

They therefore give you an idea of the company's future growth prospects and how much income you may earn from owning its shares.

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