Importance of Ratio Analysis

                             Importance of Ratio Analysis

The ratios used in financial analysis are important for the following reason:

Depending on the ratio used, it can assess whether the company is over borrowed whether it has enough cash to meet its short term obligation.

A financial analyst will rip apart the result of the company both an annual, semi annual and quarterly basis to make sure that the company is on track.

Time trends the analyst does not look at the ratios in isolation, rather he looks at the ratios over a period of time to compare how the company is performing. He will seek explanation from the company directors if there are serious blips or down word treads

It Helps In Evaluating The Firms Performance:

With the help of ratio analysis conclusion can be drawn regarding several aspects such as financial health, profitability and operational efficiency of the undertaking. Ratio points out the operating efficiency of the firm i.e. whether the management has utilized the firm’s assets correctly, to increase the investor’s wealth. It ensures a fair return to its owners and secures optimum utilization of firms assets

It helps in inter-firm comparison:

Ratio analysis helps in inter-firm comparison by providing necessary data. An interfere comparison indicates relative position. It provides the relevant data for the comparison of the performance of different departments. If comparison shows a variance, the possible reasons of variations may be identified and if results are negative, the action may be initiated immediately to bring them in line.

It helps in determining the financial position of the concern:

Ratio analysis facilitates the management to know whether the firms financial position is improving or deteriorating or is constant over the years by setting a trend with the help of ratios The analysis with the help of ratio analysis can know the direction of the trend of strategic ratio may help the management in the task of planning, forecasting and controlling.

Liquidity position:

With help of ratio analysis conclusions can be drawn regarding the Liquidity position of a firm. The liquidity position of a firm would be satisfactory if it is able to meet its current obligation when they become due. The ability to met short term liabilities is reflected in the liquidity ratio of a firm.

Long term solvency:

Ratio analysis is equally for assessing the long term financial ability of the Firm. The long term solvency s measured by the leverage or capital structure and profitability ratio which shows the earning power and operating efficiency, Solvency ratio shows relationship between total liability and total assets.

Operating efficiency:

Yet another dimension of usefulness or ratio analysis, relevant from the View point of management is that it throws light on the degree efficiency in the various activity ratios measures this kind of operational efficiency.