{"concept":{"id":52,"slug":"financial-ratio","term":"Financial ratio","shortDefinition":"A comparison between two magnitudes from the financial statements that answers a specific question about a company -- not an isolated number, but a relationship with its own meaning.","longDefinition":"A financial ratio is a comparison between two magnitudes from the financial statements -- income statement, balance sheet, or cash flow statement -- that answers a specific question about a company. Unlike an absolute figure, a ratio expresses a relationship: it divides one item by another to get a number comparable between companies of different sizes, between different periods, or between a company and its sector. An isolated ratio, however, rarely says enough on its own -- its real value lies in its evolution over time, in its comparison with similar companies, and in the context of the sector and business model it belongs to. When building any ratio, what exact items go into the numerator and denominator matters as much as the period they correspond to -- small methodological differences can significantly change how the result is interpreted."},"relations":{"requirement":[],"contrast":[],"related":[{"concept":{"id":36,"slug":"financial-statements","term":"Financial statements","shortDefinition":"The three accounting documents (income statement, balance sheet, and cash flow statement) a company publishes periodically to show its economic and financial position.","longDefinition":"Financial statements are the accounting documents a company prepares periodically to show its economic and financial position. There are three, and each answers a different question: the income statement answers whether the company made or lost money during the period; the balance sheet answers what the company owns and how it financed it at a specific point in time; the statement of cash flows answers where the company's real cash came from and where it went during the period. None of the three gives the full picture on its own -- they are connected to each other and are always read together, never in isolation."}},{"concept":{"id":53,"slug":"liquidity-ratio","term":"Liquidity ratio","shortDefinition":"A ratio that answers whether a company can cover its short-term obligations with its short-term resources -- the same question as working capital, expressed as a ratio instead of a difference.","longDefinition":"A liquidity ratio answers the same question as working capital: can the company cover its short-term obligations with its short-term resources? The difference is how it's expressed -- working capital is a subtraction (current assets minus current liabilities), while a liquidity ratio is a division (current assets divided by current liabilities), which lets you compare companies of very different sizes with a single number. A liquidity ratio above 1 is equivalent to positive working capital; below 1, to negative. A specific value isn't automatically good or bad -- it depends on the sector (some businesses operate soundly with low ratios, as already seen with working capital) and on how that ratio evolves over time for the same company."}},{"concept":{"id":54,"slug":"debt-to-equity-ratio","term":"Debt-to-equity ratio","shortDefinition":"A ratio that measures how a company is financed -- what proportion of its resources comes from debt (liabilities) versus its own capital (equity).","longDefinition":"A debt-to-equity ratio measures how a company is financed as a whole: what proportion of its resources comes from third parties (liabilities) versus what comes from its own shareholders (equity). The most common ratio compares liabilities and equity directly -- the higher that proportion, the greater the weight of debt in the company's total financing versus its own capital. The exact definition matters: comparing a company's total liabilities, which includes non-financial items like what it owes suppliers, isn't the same as comparing only its financial debt with a real cost (loans, bonds issued). A high debt-to-equity ratio isn't automatically a bad sign -- some sectors with stable assets and predictable cash flows (utilities, real estate) operate structurally with higher debt levels than others, because their business allows and justifies it."}},{"concept":{"id":55,"slug":"roe","term":"ROE","shortDefinition":"The return a company generates on the capital its own shareholders have invested -- net income divided by equity.","longDefinition":"ROE (Return on Equity) measures how much profit a company generates in relation to the capital its own shareholders have invested -- it's calculated by dividing net income by equity, both already covered in earlier modules. It's the first profitability ratio in this level, distinct from the liquidity and debt-to-equity ratios already covered: it doesn't measure whether the company can pay its debts, but whether shareholders' capital is being put to good use. A high ROE doesn't automatically mean a company is excellent -- it may reflect real business efficiency, or it may be inflated by a high level of financial leverage. Distinguishing between the two causes is exactly what the DuPont decomposition allows."}},{"concept":{"id":58,"slug":"roic","term":"ROIC","shortDefinition":"The after-tax return a company generates on all the capital invested in its business -- debt and equity together -- regardless of how it's financed.","longDefinition":"ROIC (Return on Invested Capital) measures how much after-tax operating income a company generates in relation to all the capital invested in its business -- financial debt and equity together, without distinguishing which of the two it comes from. After-tax operating income is used, not gross operating income or net income: gross would ignore the real effect of taxes on profitability, and net income would carry the effect of how the company is financed (interest on debt), exactly what ROIC seeks to isolate. Unlike ROE, which only compares profit with equity, ROIC doesn't change if a company decides to finance itself with more debt and less of its own capital, or vice versa -- it measures the performance of the business itself, not the effect the financing structure has on that performance. That's why ROIC complements ROE instead of replacing it: ROE says how much the shareholder earns on their capital; ROIC says how much the business earns per euro employed in it, whoever that euro belongs to."}}],"calculatedBy":[]},"curricularPosition":[{"id":40,"moduleId":14,"slug":"what-are-liquidity-ratios","title":"What are liquidity ratios?","summary":"You understand what a financial ratio is in general, and what liquidity ratios measure in particular -- what question they answer, not just how they're calculated.","bodyMarkdown":"## Objectives\n\nBy the end of this lesson you understand what a financial ratio is in general, and what liquidity ratios measure in particular.\n\n## Content\n\nWith the three financial statements already covered -- income statement, balance sheet, and cash flow -- the next step is turning that data into analytical information. A financial ratio is a comparison between two magnitudes from the financial statements that answers a specific question about a company. Unlike an absolute figure, a ratio expresses a relationship: it divides one item by another to get a number comparable between companies of different sizes, between different periods, or between a company and its sector.\n\nA liquidity ratio answers the same question working capital already raised in Module 3: can the company cover its short-term obligations with its short-term resources? The difference is how it's expressed -- working capital is a subtraction (current assets minus current liabilities), while a liquidity ratio is a division (current assets divided by current liabilities). Expressing it as a division, instead of a difference, lets you compare companies of very different sizes at a glance with a single number, something a subtraction doesn't let you do directly.\n\nA liquidity ratio above 1 is equivalent to positive working capital; below 1, to negative -- it's the same information, just expressed differently. And this leads to this module's central idea: a specific ratio value isn't automatically good or bad. A liquidity ratio of 1.2 can be healthy in one sector and tight in another; what matters is how that ratio evolves over time for the same company, and how it compares with similar companies -- the magnitude of a ratio, without interpretation, says little on its own.\n\nWhen calculating any ratio, what exact items go into the numerator and denominator matters as much as the period they correspond to. Two analysts can calculate \"the same\" liquidity ratio with slightly different definitions of what counts as current assets, and get numbers that aren't directly comparable to each other.\n\n## Example\n\nTwo companies can have the same liquidity ratio of 1.3 this quarter, but if one has held it steady for two years and the other has fallen from 2.5 over that same period, the second company deserves a closer look -- the trend says more than the point-in-time value.\n\n## Common mistakes\n\n- Judging a liquidity ratio as good or bad based only on its absolute value, without comparing it with the sector or the company's own historical evolution.\n- Ignoring exactly which items make up current assets and current liabilities when comparing the liquidity ratio of two companies -- small definitional differences can mean two numbers aren't really comparable.\n\n## Summary\n\nA financial ratio compares two magnitudes from the financial statements to answer a specific question. The liquidity ratio answers the same question as working capital -- whether the company covers its short-term obligations -- but expressed as a proportion. An isolated value says little; its evolution and comparison with similar companies matter.\n\n## Self-check\n\nWhy does expressing liquidity as a ratio, instead of a difference (working capital), make it easier to compare companies of different sizes?\n\nWhy can a liquidity ratio of 1.2 be healthy for one company and tight for another?","bodyHtml":"

Objectives

\n

By the end of this lesson you understand what a financial ratio is in general, and what liquidity ratios measure in particular.

\n

Content

\n

With the three financial statements already covered -- income statement, balance sheet, and cash flow -- the next step is turning that data into analytical information. A financial ratio is a comparison between two magnitudes from the financial statements that answers a specific question about a company. Unlike an absolute figure, a ratio expresses a relationship: it divides one item by another to get a number comparable between companies of different sizes, between different periods, or between a company and its sector.

\n

A liquidity ratio answers the same question working capital already raised in Module 3: can the company cover its short-term obligations with its short-term resources? The difference is how it's expressed -- working capital is a subtraction (current assets minus current liabilities), while a liquidity ratio is a division (current assets divided by current liabilities). Expressing it as a division, instead of a difference, lets you compare companies of very different sizes at a glance with a single number, something a subtraction doesn't let you do directly.

\n

A liquidity ratio above 1 is equivalent to positive working capital; below 1, to negative -- it's the same information, just expressed differently. And this leads to this module's central idea: a specific ratio value isn't automatically good or bad. A liquidity ratio of 1.2 can be healthy in one sector and tight in another; what matters is how that ratio evolves over time for the same company, and how it compares with similar companies -- the magnitude of a ratio, without interpretation, says little on its own.

\n

When calculating any ratio, what exact items go into the numerator and denominator matters as much as the period they correspond to. Two analysts can calculate "the same" liquidity ratio with slightly different definitions of what counts as current assets, and get numbers that aren't directly comparable to each other.

\n

Example

\n

Two companies can have the same liquidity ratio of 1.3 this quarter, but if one has held it steady for two years and the other has fallen from 2.5 over that same period, the second company deserves a closer look -- the trend says more than the point-in-time value.

\n

Common mistakes

\n\n

Summary

\n

A financial ratio compares two magnitudes from the financial statements to answer a specific question. The liquidity ratio answers the same question as working capital -- whether the company covers its short-term obligations -- but expressed as a proportion. An isolated value says little; its evolution and comparison with similar companies matter.

\n

Self-check

\n

Why does expressing liquidity as a ratio, instead of a difference (working capital), make it easier to compare companies of different sizes?

\n

Why can a liquidity ratio of 1.2 be healthy for one company and tight for another?

","sortOrder":1,"readingMinutes":9,"difficulty":"Básico","url":"/en/academy/business-analysis/financial-ratios/what-are-liquidity-ratios"}],"graphSummary":{"root":{"type":"concept","id":"52","depthFromRoot":0,"entity":{"type":"concept","slug":"ratio-financiero","term":"Ratio financiero","excerpt":"Comparación entre dos magnitudes de los estados financieros que responde a una pregunta concreta sobre una empresa -- no un número aislado, sino una relación con significado propio."}},"depth":1,"returnedNodes":1,"truncated":false,"hasCycle":false,"nodes":[{"type":"concept","id":"52","depthFromRoot":0,"entity":{"type":"concept","slug":"ratio-financiero","term":"Ratio financiero","excerpt":"Comparación entre dos magnitudes de los estados financieros que responde a una pregunta concreta sobre una empresa -- no un número aislado, sino una relación con significado propio."}}],"edges":[]},"relatedNews":[],"relatedEntities":[]}