Ratio Analysis of Financial Statements
Ratios are among the most popular and widely used tools of financial analysis. A ratio expresses a mathematical relation between two quantities. To be meaningful, a ratio must refer to an economically important relation. For example, there is a direct and crucial relation between an item’s sales price and its cost. Accordingly, the ratio of cost of goods sold to sales is a significant one. Ratios are tools providing us with clues and symptoms of underlying conditions. Analysis of ratios reveals important relations and bases of comparison in uncovering conditions and trends difficult to detect by inspecting individual components comprising the ratio. Financial ratios may be used by managers within a firm, by current and potential shareholders (owners) of a firm, and by a firm’s creditors.
Factors affecting Ratio Analysis
Beyond the internal operating conditions affecting a company’s ratios, we must be aware of the effects of
- Economic events
- Industry factors
- Management policies
- Accounting methods
Any weaknesses in accounting measurements impact the effectiveness of ratios. For instance, historical cost values are some times less relevant to a decision than current market values.
Uses of Ratio Analysis in a business enterprise
- It is useful for inter firm comparison which implies that company compares its performance with that of its industry peers.
- It is useful for intra firm comparison which means that company will compare the performance of various departments of the company so as to judge the best department within the company.
- It is useful in simplifying the accounting figures to make them understandable to a layman, because it is easier to understand ratios then plain figures.
- It is also useful in forecasting and planning for the future, also it helps in control by comparing the actual performance with that of forecasted performance and looking for reason for it.
- It is also used for analysis of financial statements by various interested parties like bankers, creditors, suppliers etc. for taking future decision about the company.
Ratios are relative magnitude of two selected numerical values taken from an enterprise’s financial statements. Often used in accounting, there are many standard ratios used to try to evaluate the overall financial condition of a corporation or other organization. Financial analysts use financial ratios to compare the strengths and weaknesses in various companies. Experts in Emirates Chartered Accountants Group assist the clients for using various financial analysis tools. Reach us at email@example.com