The best way to measure two seemingly identical companies is using financial ratios. They are same for every company so obviously they give an independent and objective financial measure of the performance of each. However, do note that companies operating in totally different business sectors don’t necessarily have comparable ratios – like fruit seller compared to car manufacturer – the inventory turnover is completely different for those two.

A financial ratio simply put is a relative magnitude of two or more numerical values. The numbers are taken usually from company’s own financial statements (usually from balance sheet, income statement and statement of cash flows). The ratio is expressed either in decimal values or as a percentage. As a general rule, ratio lower than 1 is shown as a percentage and ratio above 1 is shown in decimal value.

For certain types of businesses you’d expect certain ratios, so essentially those financial ratios help investors, management themselves, owners and all other interested parties to evaluate company’s performance and eventually the financial position it’s in.

There are quite a few ratios out there and to give a better overview, the most used ones are divided into following groups – liquidity (availability of cash to pay debt), activity (the rate how quickly the company converts non-cash assets into cash), debt (ability to repay debt), profitability (use of assets and control of expenses to generate acceptable level of profit) and market ratios (investor’s response to company stock).

Although financial ratios may vary slightly depending on calculation methods and terminology understanding, however, using the same formula gives a good comparison data and hence one should always be careful before simply looking at two ratios. If they are not calculated using the very same formula, they may give a slightly different result.