1. Ratio analysis: Introduction

Financial analysis usually involves the computation and comparison of a broad range of financial ratios. The purpose of these ratios is to measure a specific aspect of the financial performance of a company. There are countless ratios available and each ratio comes in many different definitions. The purpose of this section is to introduce you to the most important financial ratios. 

Broadly speaking, there are four main types of ratios:

  • Liquidity ratios
  • Activity ratios
  • Leverage ratios
  • Profitability ratios

As we have mentioned in the introduction, the purpose of these ratios is as follows:

  • Liquidity: Provides an overview of the firm's ability to cover its short-term liabilities.
  • Activity: Shows how efficiently the firm manages its assets (and how quickly it converts these assets into cash).
  • Asset structure: Provides information about the maturity of the firm's assets and whether that maturity matches with the maturity of the financing policy.
  • Debt financing: Sheds light on the firm's financing policy as well as its ability to service the contractual debt obligations.
  • Profitability: Measures the firm's ability to generate profits.

This section focuses on liquidity ratios. The other types of ratios will be the subject of the following sections. We briefly define the most relevant ratios and then apply them to the Hershey financials.