What is a financial ratio, and why is it useful in assessing financial health?

A financial ratio is defined as a numerical comparison of two financial variables, and it serves a crucial role in evaluating various aspects of an organization or individual's financial health. This assessment allows stakeholders to gain insights into efficiency, liquidity, and profitability, all essential components in understanding both short-term and long-term financial viability.

For efficiency, a financial ratio can help determine how well a company uses its assets and manages its operations to generate income. Liquidity ratios, for instance, indicate a company’s ability to cover its short-term liabilities with its short-term assets, giving insight into financial stability. Profitability ratios, on the other hand, reveal how well a company generates profit relative to revenue, assets, or equity, reflecting overall success.

The other options lack the focused definition and utility that financial ratios provide. While some involve comparisons of financial elements, none encapsulate the breadth of information financial ratios offer across multiple critical dimensions of financial health, such as the relationship between key variables like revenue and expenses or assets and liabilities. This makes the second option the most accurate representation of what a financial ratio is and its relevance in assessing financial health.