If you have ever wondered why some investors always seem to pick winning stocks, the answer often lies in their ability to analyze common financial ratios. These ratios are like the health indicators of a business, helping you understand whether a company is strong, stable, and worth your money.
In India, where retail investing is growing rapidly through platforms like Zerodha, Groww, and Upstox, knowing these financial ratios is no longer optional—it’s essential. They provide a quick snapshot of profitability, debt, liquidity, and efficiency, guiding investors to make informed decisions instead of relying on speculation or market rumors.
Let’s break down the most important financial ratios you should know as an investor, whether you are analyzing a large-cap company like Reliance Industries or a small emerging startup listed on NSE/BSE.
Key Categories of Financial Ratios
Financial ratios fall into several categories, each serving a unique purpose. Let’s explore the most critical ones with practical examples relevant to Indian markets.
1. Profitability Ratios: Measuring Earning Power
Profitability ratios show how efficiently a company generates profits. They’re the first stop for investors wanting to know if a business is a money-making machine.
Net Profit Margin
What it is: Net Profit Margin measures how much profit a company keeps from its revenue after all expenses.
Formula: (Net Profit / Revenue) x 100
Example: In FY24, Tata Consultancy Services (TCS) reported a net profit of ₹46,099 crore on revenue of ₹2,40,893 crore, yielding a net profit margin of approximately 19.14%. This high margin signals TCS’s ability to convert sales into profits efficiently, a hallmark of IT giants in India.
Why it matters: A higher margin indicates better cost management. Compare TCS’s margin with smaller IT firms to spot outperformers.
Return on Equity (ROE)
What it is: ROE measures how well a company uses shareholders’ money to generate profits.
Formula: (Net Income / Shareholders’ Equity) x 100
Example: Bajaj Finance, a leading NBFC, reported an ROE of 22% in FY24, reflecting its strong ability to deliver returns to investors. Compare this to banks like SBI, which often hover around 10–15%.
Why it matters: High ROE is a sign of efficient capital use, but beware of high debt inflating this ratio.
2. Liquidity Ratios: Assessing Short-Term Stability
Liquidity ratios reveal a company’s ability to meet short-term obligations—a critical factor in India’s volatile market.
Current Ratio
What it is: The Current Ratio compares a company’s current assets to its current liabilities.
Formula: Current Assets / Current Liabilities
Example: In FY24, Hindustan Unilever (HUL) had a current ratio of 1.4, meaning it had ₹1.4 in assets for every ₹1 in liabilities. This suggests HUL can comfortably cover short-term debts.
Why it matters: A ratio above 1 is generally safe, but too high (e.g., above 3) may indicate underutilized assets.
Quick Ratio
What it is: Also called the “acid-test ratio,” it’s a stricter measure excluding inventory from current assets.
Formula: (Current Assets – Inventory) / Current Liabilities
Example: For a retail giant like DMart, inventory is significant. Its quick ratio of 0.6 in FY24 shows limited liquid assets, but its fast inventory turnover compensates.
Why it matters: Useful for industries with slow-moving inventory, like retail or manufacturing.
3. Leverage Ratios: Understanding Debt Levels
Leverage ratios highlight how much a company relies on debt, a key consideration in India where high-debt companies can falter during economic downturns.
Debt-to-Equity Ratio
What it is: This ratio compares a company’s total debt to its shareholders’ equity.
Formula: Total Debt / Shareholders’ Equity
Example: In FY24, Reliance Industries had a debt-to-equity ratio of 0.64, indicating moderate debt levels despite its massive scale. Compare this to Vedanta, often above 1.5, signaling higher risk.
Why it matters: Lower ratios suggest financial stability, while high ratios may indicate risk, especially in capital-intensive sectors like infrastructure.
4. Efficiency Ratios: Gauging Operational Performance
Efficiency ratios show how well a company uses its assets and manages operations.
Asset Turnover Ratio
What it is: Measures how efficiently a company uses its assets to generate sales.
Formula: Revenue / Total Assets
Example: Maruti Suzuki, India’s leading carmaker, had an asset turnover ratio of 1.8 in FY24, reflecting efficient use of its manufacturing plants and distribution network.
Why it matters: Higher ratios indicate better asset utilization, crucial for capital-heavy industries.
Inventory Turnover Ratio
What it is: Shows how quickly a company sells its inventory.
Formula: Cost of Goods Sold / Average Inventory
Example: For FMCG leader ITC, a high inventory turnover of 8 in FY24 reflects its ability to move products like cigarettes and packaged foods swiftly.
Why it matters: High turnover suggests strong demand and efficient inventory management.
5. Valuation Ratios: Determining Market Value
Valuation ratios help assess whether a stock is overvalued or undervalued.
Price-to-Earnings (P/E) Ratio
What it is: Compares a company’s share price to its earnings per share (EPS).
Formula: Share Price / EPS
Example: In 2025, Infosys trades at a P/E of 25, higher than the Nifty IT index average of 20, suggesting investor confidence in its growth.
Why it matters: A high P/E may indicate overvaluation, while a low P/E could signal a bargain—or trouble.
Price-to-Book (P/B) Ratio
What it is: Compares a company’s market value to its book value.
Formula: Market Price per Share / Book Value per Share
Example: PSU banks like SBI often have P/B ratios below 1.5, signaling undervaluation, while private banks like HDFC Bank trade above 3.
Why it matters: Useful for comparing companies within the same sector, like banking or real estate.
How to Use Common Financial Ratios Effectively
Understanding common financial ratios is only half the battle—knowing how to apply them is key. Here’s a quick guide:
- Compare within industries: A P/E of 30 may be reasonable for IT companies like TCS but high for cement firms like UltraTech.
- Look at trends: A rising ROE over years signals consistent growth, as seen with Asian Paints.
- Combine ratios: Use multiple ratios (e.g., ROE with Debt-to-Equity) to get a holistic view.
- Consider the Indian context: Regulatory changes, like RBI’s monetary policies, can impact ratios like ROE for banks.
Case Study: The Rise and Fall of a Retail Giant
Consider Subhiksha, a once-popular Indian retail chain. In the early 2000s, it boasted high inventory turnover, signaling strong demand. However, its debt-to-equity ratio skyrocketed to over 2 by 2008, and poor liquidity (current ratio below 1) led to its collapse. This underscores why balancing common financial ratios is critical.
Common Financial Ratios at a Glance
| Ratio | Category | Formula | Ideal Range |
|---|---|---|---|
| Net Profit Margin | Profitability | (Net Profit / Revenue) x 100 | >10% (varies by sector) |
| Return on Equity | Profitability | (Net Income / Equity) x 100 | 15–20% |
| Current Ratio | Liquidity | Current Assets / Current Liabilities | 1–2 |
| Quick Ratio | Liquidity | (Current Assets – Inventory) / Liabilities | ~1 |
| Debt-to-Equity Ratio | Leverage | Total Debt / Equity | <1 (sector-dependent) |
| Asset Turnover Ratio | Efficiency | Revenue / Total Assets | >1 (varies by sector) |
| Inventory Turnover Ratio | Efficiency | Cost of Goods Sold / Avg. Inventory | 5–10 (varies) |
| P/E Ratio | Valuation | Share Price / EPS | 15–25 (sector-specific) |
| P/B Ratio | Valuation | Market Price / Book Value per Share | 1–3 |
Understanding common financial ratios is like learning the language of investing. They empower you to cut through the noise, analyze companies objectively, and make smarter decisions. Whether you are investing in large companies like Tata Consultancy Services or exploring mid-cap gems, ratios will always serve as your compass.
As an investor in India’s rapidly evolving market, take time to study these ratios, apply them to real company data, and watch how your confidence in making financial decisions grows.
