What is Ratio Analysis?
Ratio Analysis – Ratios are a mathematical tool that helps in defining the relationship between two figures. The analysis and interpretation of financial statements are carried out with the help of Ratio Analysis. The primary objective of ratio analysis is to help in understanding the performance of a company. Ratios reflect the strength and weaknesses of the company.
Objectives of Ratio Analysis
Following are the objectives of ratio analysis:
- Highlights the area of concern – When accounting ratios are compared with the ideal ratios prevailing in the industry, it brings to light the area which requires the immediate attention of the management.
- Facilitates comparison – With the help of ratio analysis, comparisons of intra and inter-company performances become easier.
- Evaluation of efficiency – They provide a detailed overview of the liquidity, solvency, and profitability position of the business which in its entirety helps in evaluating the efficiency of the business.
- Forecasting and planning – One of the primary objectives of ratio analysis is that they help in comparing the trend in the financials over the past years which aids the management in preparing future budgets and forecasts.
- Transparency to stakeholders – Ratio analysis helps the various stakeholders in measuring the operative efficiency of the company, thereby ensuring complete transparency.
- Better decision making – Analysis of various accounting ratios helps the management in taking better and improved decisions.
- Simplicity – It converts complex financial figures which otherwise would require a professional to interpret them into simpler data that is easily understandable by a layman.
Ratio Analysis is an indispensable tool to evaluate relationships among the various financial statement figures of a company. In the process, it provides important information regarding the profitability, solvency, and liquidity position of the company which is one of the major objectives of ratio analysis.
Chapter 5 – Accounting Ratios