A ratio is an arithmetical relation between two figures or variables. Financial ratio analysis is a study of ratios between various items or group of items in financial statements. Financial ratio analysis is an analytical tool for measuring the performance of an organisation. Ratio analysis is primarily used to analyse past performance and based on this make future projections.Financial ratio analysis is the process of establishing relationship between the variables of the balance sheet and profit and loss account, in order to find out the strength and weakness of the firm. Ratio analysis is undertaken by the various stack holders in the firm viz. trade creditors, suppliers of long-term debt, investors and the management itself. Trade Creditors are interested in the firm’s ability to meet claims in the short run. Their analysis will, therefore, be confined to the firm’s liquidity position in the short run.Suppliers of long-term debt, on the other hand are more concerned with long-term solvency and survival. They analyse the firm’s profitability over time, its ability to generate cash, its ability to repay interest and the principal amount.They also analyse the capital structure. Long-term suppliers of credit do analyse the historical financial statements but their focus is on projected or proforma financial statement to analyse its future solvency and profitability.Investors are interested in the firm’s earnings and how these earnings are used. They concentrate on the firm’s present and future profitability. They are also interested in the firm’s financial structure to the extent that it influences the firm’s earnings ability and risk.The management of the firm would be interested in every aspect of the financial ratio analysis as, this helps them assess how efficiently and effectively the firm’s resources are being used.
Nature of Ratio Analysis
Ratios are used as a benchmark for evaluating the financial position and performance of a firm. Accounting figures presented in the financial statements would convey some meaning only if they are seen in relation to the other variables. Ratios help to other summarise large quantities of financial information (data). Through ratio analysis, one can make a qualitative judgment. The ratios reflect a quantitative relationship among different variables.
Standards of Comparison
A ratio in itself would not provide any useful information, until and unless the ratios are compared with some standard. Standards of comparison may consist of, Past ratios, i.e., ratios calculated from the past financial statements of the same firm. Competitor’s ratios, i.e., ratios of some selected firms preferably the firms having similar turnover. Another approach is to compare the firm’s ratios with that of the market leader. Industry ratios, i.e., the average ratios of the industry to which the firm belongs Projected ratios, i.e., ratios calculated using the projected or proforma financial statements of the same firm.
Nature of Ratio Analysis
Ratios are used as a benchmark for evaluating the financial position and performance of a firm. Accounting figures presented in the financial statements would convey some meaning only if they are seen in relation to the other variables. Ratios help to other summarise large quantities of financial information (data). Through ratio analysis, one can make a qualitative judgment. The ratios reflect a quantitative relationship among different variables.
Standards of Comparison
A ratio in itself would not provide any useful information, until and unless the ratios are compared with some standard. Standards of comparison may consist of, Past ratios, i.e., ratios calculated from the past financial statements of the same firm. Competitor’s ratios, i.e., ratios of some selected firms preferably the firms having similar turnover. Another approach is to compare the firm’s ratios with that of the market leader. Industry ratios, i.e., the average ratios of the industry to which the firm belongs Projected ratios, i.e., ratios calculated using the projected or proforma financial statements of the same firm.
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