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📖 Chapter 3 (Part 8): Key Financial Ratios Explained – How to Analyse a Company Like a Pro

🔹 Introduction

You may understand:
✔️ Business model
✔️ Revenue, profit
✔️ Balance sheet
✔️ Cash flow
✔️ Free cash flow

But when you open Screener.in or an annual report…
you’ll see numbers everywhere:
P/E, ROE, ROCE, Debt/Equity, EPS, Margins…

📌 These numbers are called Financial Ratios.
They help investors compare, judge, and decide whether a company is strong or weak.

Also Read: Free Cash Flow (FCF) Explained – The Real Indicator of Company Strength

🔹 What Are Financial Ratios?

Financial ratios are simple calculations made using a company’s financial data to understand:

Profitability
Efficiency
Debt levels
Valuation
Growth quality

📘 Think of ratios as health indicators for a company — like BP, sugar, cholesterol for humans.

🔹 Why Financial Ratios Matter

1️⃣ Convert raw numbers into meaningful insights
2️⃣ Help compare two companies easily
3️⃣ Reveal hidden strengths & weaknesses
4️⃣ Prevent emotional or hype-based investing

👉 Numbers alone confuse.
👉 Ratios explain the story behind numbers.

🔹 MUST-KNOW Financial Ratios (Beginners Focus)

1️⃣ Price to Earnings Ratio (P/E)

📘 Meaning:
How much investors are willing to pay for ₹1 of company’s profit.

Formula:
P/E = Share Price ÷ Earnings Per Share (EPS)

Example:

Share price = ₹200
EPS = ₹20
➡️ P/E = 10

💡 Lower P/E may indicate undervaluation
⚠️ Very high P/E may mean overvaluation or high growth expectations

2️⃣ Earnings Per Share (EPS)

📘 Meaning:
Profit earned for each share.

Formula:
EPS = Net Profit ÷ Total Shares

💡 Rising EPS year after year = strong business growth
⚠️ Falling EPS = warning sign

3️⃣ Return on Equity (ROE)

📘 Meaning:
How efficiently a company uses shareholders’ money.

Formula:
ROE = Net Profit ÷ Shareholders’ Equity

Example:
ROE = 18% → Company earns ₹18 for every ₹100 invested by owners.

💡

ROE > 15% → Good
ROE > 20% → Excellent

4️⃣ Return on Capital Employed (ROCE)

📘 Meaning:
How efficiently a company uses total capital (debt + equity).

Formula:
ROCE = EBIT ÷ Capital Employed

💡 ROCE is better than ROE for debt-heavy companies.
Consistently high ROCE = strong competitive advantage.

5️⃣ Debt to Equity Ratio

📘 Meaning:
How much debt a company has compared to owners’ money.

Formula:
Debt / Equity

💡

< 0.5 → Very safe
0.5–1 → Acceptable
1 → Risky (depends on sector)

⚠️ High debt = pressure during bad times.

6️⃣ Net Profit Margin

📘 Meaning:
How much profit is left from every ₹100 of sales.

Formula:
Net Profit ÷ Revenue × 100

💡

Higher margin = pricing power + cost control
Falling margin = rising costs or competition

7️⃣ Current Ratio

📘 Meaning:
Company’s ability to pay short-term obligations.

Formula:
Current Assets ÷ Current Liabilities

💡

1.5 → Healthy
< 1 → Liquidity risk

🔹 Ratio Comparison Example

Company	ROE	Debt/Equity	Net Margin
Company A	20%	0.2	15%
Company B	10%	1.5	6%

👉 Company A is financially stronger & safer.

🔹 Common Beginner Mistakes

❌ Looking at only one ratio
❌ Comparing companies from different sectors
❌ Ignoring trends (YoY changes matter!)
❌ Believing “high P/E = bad” blindly

📌 Always look at combination of ratios + trend + business quality.

🔹 Where to Find These Ratios?

Screener.in
Annual Reports
NSE / BSE websites
Company investor presentations

🔹 Q&A Section

Q1: Which ratio is most important?
A: No single ratio. Use ROE + ROCE + Debt + Margins together.

Q2: Can ratios be manipulated?
A: Some can be influenced short-term — that’s why trends matter.

Q3: Are high ratios always good?
A: Not always. Extremely high values may indicate risk or one-time gains.

🔹 Key Takeaways

Financial ratios simplify company analysis
They help compare, judge, and avoid bad investments
Focus on profitability, efficiency, and debt control
Trends matter more than one-year numbers
Ratios + business understanding = winning combination

📘 If you master ratios, you’ll never invest blindly again.