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 valuable insights into various aspects of a company's operations, such as profitability, liquidity, leverage, and efficiency. By comparing these ratios over time or against industry benchmarks, stakeholders—including investors, management, and analysts—can assess how well a company is doing financially and identify trends or areas for improvement.

For instance, key profitability ratios such as the net profit margin help reveal how efficiently a company converts sales into actual profit. Liquidity ratios, like the current ratio, indicate a company's ability to meet short-term obligations. They can also signal potential financial distress if the ratios are weak. Overall, financial ratios serve as essential tools for conducting a thorough financial analysis and making informed investment or business decisions.