Although analyzing financial statements can be quite complex, a general idea of a company's financial position can be determined through the use of ratio analysis. Financial performance ratios can be calculated from the balance sheet and income statement. These ratios should be compared with the industry average or the company's prior years of performance. For example, young companies will have purchased assets at a different price and will likely have a different capital structure than older companies. In addition to ratio analysis, a company's cash flow position is of critical importance and should be assessed.
Cash flow shows how much actual cash a company possesses.
Profit Ratios Profit ratios measure the efficiency with which the company uses its resources. The more efficient the company, the greater is its profitability. It is useful to compare a company's profitability against that of its major competitors in its industry. Such a comparison tells whether the company is operating more or less efficiently than its rivals. In addition, the change in a company's profit ratios over time tells whether its performance is improving or declining.