3.2Key financial ratios
The essentials in 30 seconds
- A ratio puts two amounts in relation to produce a meaningful, comparable indicator: an isolated figure says nothing.
- Four families: profitability (is it earning a living?), solvency (solid long term?), liquidity (can it pay soon?), indebtedness (too much debt?).
- A ratio is read against a benchmark, the sector and a trend — never in isolation; a few well-read ratios beat an avalanche.
Running mini-case — Rachid and his 200,000 of debt
Rachid discovers “200,000 of debt” in his accounts and panics. His accountant calms him down: compared with equity, with the trading sector and with last year, those debts tell another story — stable borrowing financing fast-moving stock. Rachid learns never to read a figure alone again.
Sequel of case 3.1 — Rachid moves from balances to ratios.
1. Putting two amounts in relation
Financial ratios put two amounts from the accounts in relation to produce a meaningful, comparable indicator. An isolated figure ("€200,000 of debt") says nothing; compared with another amount (equity, the sector, last year), it becomes interpretable.
Four families structure the analysis: profitability (is the business earning a good living?), solvency (solid long term? e.g. financial autonomy), liquidity (can it pay soon? current assets over short-term liabilities), indebtedness (too dependent on banks? gearing).
2. Interpret, don't accumulate
The secret is not calculating dozens of ratios, but choosing a few relevant ones and above all interpreting them: a ratio is read against a benchmark, the sector and a trend — never in isolation.
There is no universal "good" level: borrowing that is normal in heavy industry would be alarming in services. The right reflex is the set: one or two ratios per family telling one coherent story of financial health. Ratios are the language of financial analysis: diagnose and compare.
🔎 Concrete example — A ratio is never read alone
Rachid applies the three references to his borrowing.
"€200,000 of debt" → meaningless alone.
"Debt / equity" vs sector + last year + benchmark.
→ borrowing normal in industry would be alarming in services.Result: a diagnosis, not an avalanche of figures.
Reflex: a few well-chosen, well-interpreted ratios.
Section vocabulary
- Financial ratio
- Relation between two amounts from the accounts producing an interpretable, comparable indicator.
Simple example: debt over equity: borrowing becomes readable.
What it is not: "€200,000 of debt" brandished alone as proof.
Reflex: facing any figure, ask "compared with what?".
- Profitability
- Ability to generate a result relative to the means employed (economic, financial profitability, margins).
Simple example: Rachid tracks his margin over his activity year on year.
What it is not: turnover alone, with no result and no means employed.
Reflex: always relate the gain to the means it required.
- Solvency
- Ability of the business to meet its long-term obligations (e.g. financial autonomy).
Simple example: equity over balance-sheet total: Rachid's solidity.
What it is not: the ability to pay the next maturity (that is liquidity).
Reflex: check long-term solidity before judging the short term.
- Liquidity
- Ability to honour short-term maturities (current assets over short-term liabilities).
Simple example: Rachid checks he can pay near maturities with his current assets.
What it is not: the wealth or long-term solidity of the business.
Reflex: test "can I pay soon?" before each commitment.
- Indebtedness (gearing)
- Weight of financial debt over equity; measures dependence on external financing.
Simple example: Rachid's debts vs his equity and his sector.
What it is not: the gross amount of debt read with no reference.
Reflex: compare with the sector and last year before concluding.
In practice — Calculating and interpreting the key ratios
- Choose a few relevant ratios per family: profitability, solvency, liquidity, indebtedness.
- Calculate them by putting two amounts in relation (e.g. equity / total for financial autonomy).
- Interpret each ratio against a benchmark, the sector and the evolution over time — never in isolation.
- Draw an overall diagnosis: profitability, solidity, ability to pay, dependence on debt.
Ready-to-say script — present your financial health in 1 min
"Our debts are 200,000, which means nothing alone. Against our equity, our sector and last year, they are stable and finance fast-moving stock. Our watch point is short-term liquidity: that is where I want to act."
To say to your banker or partner, compared ratios in front of you.
Copy-paste template — express ratios sheet
EXPRESS RATIOS SHEET — year: _______________
PROFITABILITY (earning a living?): ratio = _____ → vs sector: _____ / vs last year: _____
SOLVENCY (solid long term?): equity / total = _____ → reading: _____
LIQUIDITY (can it pay soon?): current assets / short-term debt = _____ → reading: _____
INDEBTEDNESS (too much debt?): debt / equity = _____ → vs sector: _____
OVERALL DIAGNOSIS (one coherent story): _______________Small business / small budget
Four ratios are enough, one per family, calculated once a year with the accountant and compared with last year.
SME Algiers
Compare with comparable local sector businesses; track the trend over three years to smooth out swings.
Trading / retail
Watch borrowing that finances stock: weigh debt against the turnover speed of goods.
Services
Little stock, normally little debt: a debt level banal in industry becomes a warning signal here.
✓ Best practices
- Choose a few relevant ratios rather than stacking dozens.
- Always interpret against the sector, the benchmark and the trend.
- Tell one coherent story with a set of ratios.
✗ Common pitfalls
- Concluding on an isolated ratio, with no reference.
- Believing in one universal “good” level valid for every sector.
- Stacking dozens of ratios: false rigour, drowned information.
Key takeaways
- A ratio puts two amounts in relation to produce a meaningful, comparable indicator.
- Families: profitability, solvency, liquidity, indebtedness.
- Choose a few relevant ratios rather than stacking dozens.
- A ratio is interpreted against a benchmark, the sector and a trend — never in isolation.
48h challenge — apply tomorrow
Take 1 figure that worries you in your accounts, turn it into a ratio (against another amount) and compare it with last year. Note what the comparison changes in your reading.
- I can name the four ratio families and their question.
- I know why a ratio is never read alone.
- I have compared 1 ratio of my business with last year.
Frequently asked questions
Is there a universal “good” level for each ratio?
Rarely in absolute terms. A ratio is interpreted against the sector (borrowing normal in heavy industry would be alarming in services), the trend (a deteriorating ratio is a signal even if still correct) and benchmarks that stay reference points, not absolute truths. The right reflex: compare (last year, competitors, sector) and cross-check several ratios.
How many ratios must you calculate to analyse a business?
Far fewer than you think: one or two per family is enough (profitability, solidity, liquidity, indebtedness). The real work is not calculation but interpretation: what does this set say about health, strengths and fragilities? A few well-chosen, well-read ratios beat an avalanche of figures.
Rachid reads “200,000 of debt” and wants to conclude alone. What is the right analysis reflex?