What Is Ratio Analysis? Before discussing ratio analysis, it is wise to clarify the term ratio. what is the ratio? Ratios can be found out by dividing one number by another number. The ratio shows how one number is related to another. It may be expressed in the form of co-efficient, percentage, proportion, or ratio.
Some Scholars Definition:
“Ratio is the relationship of one item to another expressed in the simple mathematical form.” – Prof. Kanedy.
“Ratio is the relationship between two financial variables.” – IM Pandey.
“A Ratio is defined as the indicated quotient of two mathematical expressions and as the relationship between two things.” – Webster.
Definition of Ratio Analysis
“The ratio analysis is the systematic use of ratio to interpret the financial statements so that the strengths and weaknesses of a firm, as well as its historical performance and current financial condition, can be determined.” – Khan and Jain.
Ratio analysis helps to summarise the large quantities of financial data and to make a qualitative judgment about the firm’s financial performance.
Classification of Accounting Ratios
Ratios may be classified in a number of ways to suit any particular purpose. Different kinds of ratios are selected for different types of situations.
Mostly, the purpose, for which the ratios are used and the kind of data available determine the nature of the analysis. The various accounting ratios can be classified as follows:
Advantages of Ratio Analysis
Ratio analysis is an important and age-old technique of financial analysis. The following are some of the advantages/benefits of ratio analysis.
(a) Simplifies financial statements:
It simplifies the comprehension of financial statements. Ratios tell the whole story of changes in the financial condition of the business.
(b) Facilitates inter-firm comparison:
It provides data for inter-firm comparison. Ratios highlight the factors associated with successful and unsuccessful firms. They also reveal strong firms and weak firms and unsuccessful firms. They also reveal strong firms and weak firms overvalued and undervalued firms.
(c) Helps in planning:
It helps in planning and forecasting. Ratios can assist management, in its basic functions of forecasting. Planning, coordination, control, and communications.
(d) Makes inter-firm comparison possible:
Ratio analysis also makes possible comparison of the performance of different divisions of the firm. The ratios are helpful in deciding about their efficiency or otherwise n the past and likely performance in the future.
(e) Helps in investment decisions:
It helps in investment decisions in the case of investors and leading decisions in the case of bankers etc.
Standards Used in Ratio Analysis
a) Conventional standard
b) Comparative business
c) Last year ratio
d) Industrial average ratio.
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