# Ratio Analysis and AI Interpretation

Raw financial numbers are nearly meaningless in isolation. Is $10M in revenue good? It depends on the industry, the company size, last year's revenue, and what competitors are doing. Financial ratios normalize these numbers, making companies comparable regardless of size.

AI is an excellent ratio analysis partner because it can calculate ratios, explain what they mean, compare them to benchmarks, and identify trends — all in a single prompt.

The Four Ratio Categories

1. Liquidity Ratios (Can They Pay Their Bills?) - Current Ratio = Current Assets / Current Liabilities - Above 1.5 = comfortable. Below 1.0 = potential cash crunch. - Quick Ratio = (Current Assets - Inventory) / Current Liabilities - More conservative — excludes inventory which may not be quickly convertible to cash.

2. Profitability Ratios (Are They Making Money Efficiently?) - Gross Margin = (Revenue - COGS) / Revenue - How much profit per dollar of sales before overhead. - Operating Margin = Operating Income / Revenue - How much profit per dollar after all operating costs. - Net Margin = Net Income / Revenue - The bottom line — what percentage of revenue becomes profit. - Return on Equity (ROE) = Net Income / Shareholders' Equity - How efficiently the company uses investor capital.

3. Efficiency Ratios (How Well Are They Using Resources?) - Inventory Turnover = COGS / Average Inventory - How quickly inventory sells. Higher = more efficient. - Days Sales Outstanding (DSO) = (Receivables / Revenue) x 365 - How long it takes to collect payment. Lower = better cash flow. - Asset Turnover = Revenue / Total Assets - Revenue generated per dollar of assets.

4. Leverage Ratios (How Much Risk from Debt?) - Debt-to-Equity = Total Liabilities / Shareholders' Equity - Higher = more debt-financed. Acceptable levels vary by industry. - Interest Coverage = Operating Income / Interest Expense - Can they afford their debt payments? Below 2x is concerning.