What is the primary purpose of financial ratios?

The primary purpose of financial ratios is to compare the financial performance of different companies. These ratios allow analysts, investors, and stakeholders to benchmark a company against its peers or industry standards, providing insights into operational efficiency, profitability, liquidity, and solvency. By analyzing these ratios, users can identify strengths and weaknesses, determine valuations, and make informed investment decisions.

Financial ratios facilitate straightforward comparisons by normalizing financial data, making it easier to evaluate how one company stands relative to others within the same sector or industry. For example, a common ratio such as the Price-to-Earnings (P/E) ratio can show how a company's stock price compares to its earnings in relation to similar companies, which aids in investment decisions.

While assessing a company's historical performance, predicting future market trends, and measuring stock volatility may all be relevant to financial analysis, these actions do not capture the distinct primary function of financial ratios, which is rooted in comparison across entities within a specific context.