Let us see how ratio analysis works. While a detailed explanation of ratio analysis is beyond the scope of this section, we will focus on a technique, which is easy to use. It can provide you with a valuable investment analysis tool. This technique is called cross-sectional analysis . Cross-sectional analysis compares financial ratios of several companies from the same industry.
Ratio analysis can provide valuable information about a company's financial health.
A financial ratio measures a company's performance in a specific area. For example, you could use a ratio of a company's debt to its equity to measure a company's leverage. By comparing the leverage ratios of two companies, you can determine which company uses greater debt in the conduct of its business. A company whose leverage ratio is higher than a competitor's has more debt per equity. You can use this information to make a judgment as to which company is a better investment risk.