Importance of Ratio Analysis
Management Accounting
IMPORTANCE OF RATIO ANALYSIS
Ratio analysis is a tool used by individuals to conduct a quantitative analysis of information in a company's financial statements. Ratios are calculated from current year numbers and are then compared to previous years, other companies, the industry, or even the economy to judge the performance of the company. Ratio analysis is predominately used by proponents of fundamental analysis.
The ratio analysis is one of the most important tools of financial analysis. The various groups of people having different interest are interested in analysing the financial information. These groups use the analysis to determine particular financial characteristics of which they are interested. The importance of ratio analysis can be summarized for various groups of peoples vested with the diversified interests are as under:
1. For short term creditors – The short term creditors like bankers and suppliers of materials can determine the firm’s ability to meet its current obligation with the help of liquidity ratio and quick ratio.
2. For long term creditors – The long term creditors like debenture holders and financial institutions can determine the firm’s long term financial strength and survival with the help of leverage or capital structure ratio as debt equity ratio.
They can know :
a) What sources of long term are employed?
b) What is the relationship between various sources of finances?
c) Is there any risk to the solvency of the firm due to the employment of excessive long term debts?
3. For the management – The management can determine the operating efficiency with the firm is utilizing its various in generating the sales revenues with the help of activity ratio such as capital turnover ratio, stock turnover ratio, etc.
4. For investors – The investor can determine the magnitude and direction of the movements in firm’s earning with the help of profitability ratio such as earning per share etc.
IMPORTANCE OF RATIO ANALYSIS
Ratio analysis is a tool used by individuals to conduct a quantitative analysis of information in a company's financial statements. Ratios are calculated from current year numbers and are then compared to previous years, other companies, the industry, or even the economy to judge the performance of the company. Ratio analysis is predominately used by proponents of fundamental analysis.
The ratio analysis is one of the most important tools of financial analysis. The various groups of people having different interest are interested in analysing the financial information. These groups use the analysis to determine particular financial characteristics of which they are interested. The importance of ratio analysis can be summarized for various groups of peoples vested with the diversified interests are as under:
1. For short term creditors – The short term creditors like bankers and suppliers of materials can determine the firm’s ability to meet its current obligation with the help of liquidity ratio and quick ratio.
2. For long term creditors – The long term creditors like debenture holders and financial institutions can determine the firm’s long term financial strength and survival with the help of leverage or capital structure ratio as debt equity ratio.
They can know :
a) What sources of long term are employed?
b) What is the relationship between various sources of finances?
c) Is there any risk to the solvency of the firm due to the employment of excessive long term debts?
3. For the management – The management can determine the operating efficiency with the firm is utilizing its various in generating the sales revenues with the help of activity ratio such as capital turnover ratio, stock turnover ratio, etc.
4. For investors – The investor can determine the magnitude and direction of the movements in firm’s earning with the help of profitability ratio such as earning per share etc.