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Ratio Analysis (Importance & Objectives)

Written By: Roshni Bhatia on May 14, 2011 No Comment


ANALYSIS OF FINANCIAL STATEMENTS

The traditional financial statements that comprise of the balance sheet and profit and loss account do not give enough information related to financial operations of the company. These financial statements prepared as per the statutory requirement of law need to be analysed in order to evaluate the past performance of the company and the future prospects.

There are many tools of financial statement analysis like:

  1. Ratio Analysis
  2. Dupont Analysis
  3. Trend Analysis
  4. Commonsize statements
  5. Comparative Analysis

The most widely used tool is Ratio Analysis.

RATIO ANALYSIS

It is the most widely used tool since it compares risk and return relationships of firms from various aspects. Ratio analysis is the method or process by which the relationship of items or group of items in the financial statements are computed, determined and presented.
It is an attempt to derive quantitative measures or guides concerning the financial health and profitability of a business enterprise. It can be used both in trend and static analysis. There are several ratios at the disposal of an analyst but the group of ratios he would prefer depends on the purpose and objectives of analysis.

IMPORTANCE OF RATIO ANALYSIS
Accounting ratios are very useful in assessing the financial position and profitability of a business enterprise. This can be achieved through comparison by ratios in the following ways:
• For same enterprise over a no. of years(horizontal analysis)
• For one enterprise against another in the same industry(third-dimension analysis)
• For one enterprise against the industry as a whole
• For one enterprise against the pre determined standards
• For inter departmental comparisons within an organization

OBJECTIVES OF RATIO ANALYSIS
Ratios are worked out to analyse the following aspects of an enterprise:
a. Solvency:
1. Long term
2. Short term
3. Immediate
b. Profitability
c. Operational Efficiency
d. Credit standing
e. Effective utilization of resources
f. Investment Analysis

To read more on uses of ratios:  Uses of Ratio Analysis

To read more on classification of ratios: Classification of Ratios

To read more on Limitations of ratios: Limitations of Ratio Analysis

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