Learn On Your Own Ratio Analysis:

The term "Ratio Analysis" is the system of analyzing the financial statements and interpreting financial results of a concern for a particular period of operations with the help of 'ratio'. Ratio analysis used to determine the financial soundness of a business concern.

The term 'ratio' refers to the mathematical relationship between any two inter-related variables. In other words, it establishes relationship between two items expressed in quantitative form.

Objectives of Ratio Analysis:
  1. To provide a measure of profitability of a firm and find out problem areas (if any) and improve them.
  2. To Evaluate the operational efficiency and do away with mis management of assets
  3. To determine the long-term solvency of the firm with the help of Debt-Equity Ratio, Leverage ratios, etc
  4. Ratios can be compared to the industry standards to get a better understanding of its financial health and fiscal position. Corrective action can be taken (if required)
Types of Ratio Analysis Or Interpretations of Ratios:

The analysis or interpretations in question may be of various types.

  1. Analysis or Interpretation of an Individual (or) Single ratio.
  2. Analysis or Interpretation by referring to a group of ratios.
  3. Analysis or Interpretation of ratios by trend.
  4. Analysis or Interpretation by inter-firm comparison.
Principles of Ratio Selection:

The following principles should be considered before selecting the ratio:

  1. Ratio should be logically inter-related.
  2. Pseudo ratios should be avoided.
  3. Ratio must measure the material factor of business.
  4. Cost of obtaining information should be borne in mind.
  5. Ratio should be in minimum numbers.
  6. Ratio should facilitate comparison.
Advantages of Ratio Analysis:

In analyzing ratios it is necessary to establish a relationship between two accounting figures and highlight significant information to the management or users who can analyze the business situation and take corrective measures (if required) or supervise their performance in a meaningful way.

The following are the advantages of ratio analysis:

  1. It facilitates the accounting information in a simplified and summarized form.
  2. It chalks out the inter-relationship between the facts and figures of various segments of business.
  3. Ratio analysis helps to minimize wastages and inefficiencies.
  4. It helps the management in decision making process.
  5. It helps in management functions like planning, organizing, staffing directing, controlling and forecasting.
  6. Ratio analysis reveals the productive and non-productive activities of a concern and thus helps to improve the efficiency.
  7. Ratio analysis helps management in fixing responsibilities.
  8. Ratio analysis helps in determining liquidity, profitability and solvency of a concern.