Accounting For Dummies®, 4th Edition

13.4. Analyzing Financial Statements with Ratios

Financial statements have lots of numbers in them. (Duh!) All these numbers can seem overwhelming when you're trying to see the big picture and make general conclusions about the financial performance and condition of the business. One very useful way to interpret financial reports is to compute ratios — that is, to divide a particular number in the financial report by another. Financial statement ratios are also useful because they enable you to compare a business's current performance with its past performance or with another business's performance, regardless of whether sales revenue or net income was bigger or smaller for the other years or the other business. In other words, using ratios cancels out size differences. (I bet you knew that, didn't you?)

Surprisingly, you don't find too many ratios in financial reports. Publicly owned businesses are required to report just one ratio (earnings per share, or EPS), and privately owned businesses generally don't report any ratios. Generally accepted accounting principles (GAAP) don't demand that any ratios be reported (except EPS for publicly owned companies). However, you still see and hear about ratios all the time, especially from stockbrokers and other financial professionals, so you should know what the ratios mean, even if you never go to the trouble of computing them yourself.

NOTE

Ratios do not provide final answers — they're helpful indicators, and that's it. For example, ...