Importance of RatioAnalysis
Dr. M. Vadivel
Assistant Professor
Department of B. Com PA
SRCAS, CBE.
2.
Importance of RatioAnalysis
Ratio analysis is critical for analyzing a company’s financial
condition, liquidity, profitability, risk, efficiency, operational effectiveness,
and wise use of cash. It also illustrates the tendency or comparison of
economic conditions, which is useful for corporate shareholders’
investment decisions. Different types of accounting ratios provide different
information and serve different purposes.
3.
Importance of RatioAnalysis
Liquidity Ratios: These ratios tell about a company’s capacity to pay off short-
term debt.
Leverage Ratios: These are responsible to examine the company’s debt level in
relation to its capital structure.
Efficiency Ratios: These show a company’s efficiency in the utilization of its
resources.
Profitability Ratios: The company’s ability to create profits from revenue is known
by these ratios.
Market Value Ratios: Analysis of the company’s stock price is done with the help
of these ratios.
4.
Advantages of RatioAnalysis
Planning: Through doing trend analysis, it aids in predicting and planning.
Estimation: By analyzing prior trends, it is possible to estimate the firm’s
budget.
Informative: It gives users accounting information and important information
about the business’s performance.
Solvency: It aids in determining the firm’s liquidity as well as its long-term
solvency.
Comparison: It helps in the comparison of different firms on various scales as
well as inter-firm analysis.
5.
Limitations of RatioAnalysis
Historical Information: Information used in the analysis is based on past results that
the company releases. Therefore, ratio analysis metrics do not necessarily represent
future company performance.
Inflationary effects: Financial statements are provided on a regular basis, thus there
are time gaps between each publication. If there has been inflation between periods,
actual prices are not represented in the financial accounts.
Changes in accounting policies: If the company’s accounting standards and
practices have changed, this may have a substantial impact on financial reporting.
Operational changes: A company’s operational structure can alter dramatically, from
its supply chain strategy to the product it sells. When large operational changes occur,
comparing financial indicators before and after the change may lead to inaccurate
inferences about the company’s accomplishments and various reports.
