As the name suggests, ratios entail the compare of two variables. Hence ratios are the relative measures of financial statements. There are different facets of the income statement and the balance sheet which, when combined, can give interesting insights into the performance and health of the company in question. If you look at the income statement or the balance sheet in isolation then you don’t get the true analytical perspective. The answer lies in ratios. Ratios are always relative as opposed to profit and sales numbers that are absolute in nature.

There are various permutations and combinations based on which ratios can be drawn and evaluated. Ratios can be from within a single financial statement or from different financial statements. For example, the net profit margin and the operating margins are examples of ratios that are purely derived from the income statement because they use the top line and the bottom line figures. At the same time the current ratio and the debt/equity ratio are entirely derived from the balance sheet. But, there are other ratios which combine the income statement and the balance sheet to get a clearer picture. Ratios like the asset turnover ratio and the return on equity (ROE) or return on capital employed (ROCE) entail data points from the income statement and also from the balance sheet. For example, the ROE divides the net profit by the total equity of the company. ROCE divides the EBITDA by the total capital employed that includes equity and long term debt. It is this ability to cross breed parameters from different financial statements that make ratios so powerful.