What role do financial ratios play in financial analysis?

Financial ratios are essential tools used in financial analysis as they provide a quantitative basis for evaluating a company's performance and liquidity. By computing these ratios, analysts can gain insights into various aspects of a company’s operations, including its ability to meet short-term obligations, manage its assets effectively, and generate profits.

Liquidity ratios, such as the current ratio and quick ratio, specifically assess a company's ability to cover its short-term liabilities with its short-term assets. Performance ratios, like return on equity or profit margin, highlight how effectively a company is utilizing its resources to generate earnings.

Together, these metrics paint a comprehensive picture of a company's financial health, allowing stakeholders to make informed decisions regarding operations, investments, and potential improvements. This analytical approach is critical for both internal management and external stakeholders like investors and creditors, thus underscoring the importance of performance and liquidity analysis through the use of financial ratios.