Skip to main content

Unit III - Ratio Analysis


Meaning of Ratio Analysis:

Now, we have previously learned what ratios are. They are a comparison of two numbers with respect to each other. Similarly, in finance, ratios are a correlation between two numbers, or rather two accounts. So two numbers derived from the financial statement are compared to give us a more clear understanding of them. This is an accounting ratio.

Objectives of Ratio Analysis:

Interpreting the financial statements and other financial data is essential for all stakeholders of an entity. Ratio Analysis hence becomes a vital tool for financial analysis and financial management. Let us take a look at some objectives that ratio analysis fulfils.

Advantages of Ratio Analysis:

When employed correctly, ratio analysis throws light on many problems of the firm and also highlights some positives. Ratios are essentially whistle-blowers, they draw the managements attention towards issues needing attention. Let us take a look at some advantages of ratio analysis.
Ratio analysis will help validate or disprove the financing, investment and operating decisions of the firm. They summarize the financial statement into comparative figures, thus helping the management to compare and evaluate the financial position of the firm and the results of their decisions.
It simplifies complex accounting statements and financial data into simple ratios of operating efficiency, financial efficiency, solvency, long-term positions etc.
Ratio analysis help identify problem areas and bring the attention of the management to such areas. Some of the information is lost in the complex accounting statements, and ratios will help pinpoint such problems.
Allows the company to conduct comparisons with other firms, industry standards, intra-firm comparisons etc. This will help the organization better understand its fiscal position in the economy.

Limitations of Ratio Analysis:

While ratios are very important tools of financial analysis, they d have some limitations, such as
The firm can make some year-end changes to its financial statements, to improve their ratios. Then the ratios end up being nothing but window dressing.
Ratios ignore the price level changes due to inflation. Many ratios are calculated using historical costs, and they overlook the changes in price level between the periods. This does not reflect the correct financial situation.
Accounting ratios completely ignore the qualitative aspects of the firm. They only take into consideration the monetary aspects (quantitative)
There are no standard definitions of the ratios. So firms may be using different formulas for the ratios. One such example is Current Ratio, where some firms take into consideration all current liabilities but others ignore bank overdrafts from current liabilities while calculating current ratio
And finally, accounting ratios do not resolve any financial problems of the company. They are a means to the end, not the actual solution.
Video Lecture Links:

https://youtu.be/hMoOk6iI564
 


Contents   1   2   3   4   5

Labels:

Comments

Post a Comment

Popular posts from this blog

Poem 2 - Solitude - by Alexander Pope (Sem IV)

“Ode on Solitude” is a poem written by Alexander Pope. In this poem, the Pope expresses his desire to lead a quiet and secluded life, with minimal assets. The poet prefers to have just a few acres of land. He would not like to go anywhere out of his native region. He would like to breathe the air of his ancestral place. He wants to have a comfortable and self-sufficient life. He would get milk from the herds, food from the fields, wool for clothing from the sheep. He prefers to be under the shadow of trees during summer, and use the wood to make fire during the winter. All that required is good health, peace of mind and quietness.  He would spend his days in study and leisure, and live a life of innocence and thought. The final note is that the poet would like to live an oblivious life, with no necessity to be mourned or missed once he passes away.
Post a Comment
Read more

Interview Question: Share Market

  Interview Questions (Continued...) Share Market What is ADR? An American depository receipt is a certificate issued by a U.S. bank that represents shares in foreign stock. These certificates trade on American stock exchanges. ADRs and their dividends are priced in U.S. dollars. ADRs represent an easy, liquid way for U.S. investors to own foreign stocks. These investments may open investors up to double taxation and there are a limited number of options available. What is GDR? A global depositary receipt (GDR) is a certificate issued by a bank that represents shares in a foreign stock on two or more global markets. GDRs typically trade on American stock exchanges as well as Eurozone or Asian exchanges. GDRs and their dividends are priced in the local currency of the exchanges where the shares are traded. GDRs represent an easy, liquid way for U.S. and international investors to own foreign stocks. ...
Post a Comment
Read more

Phrose 1 - The Town Week - by E.V. Lucas (Sem IV)

In his celebrated essay, “The Town Week” E. V. Lucas very artistically painted various moods and attitudes of the urban people in the seven days of a week. On Monday, people wake up from their dreamy and lazy languor. The day seems flat as if without any colour and flavour. The fun and relic of the Saturday and Sunday have gone. They look morose and pale. A dull and monotonous life is going to eat them up once again. Reluctantly, people come back to their workplaces from their village home. The town becomes populated and busy. The local trains are over-crowded. They do not put their interest in their work. So, most of the time, they enjoy gossiping with their colleagues about their week-end spending. The laziness of Monday almost dries up on Tuesday. People become more active and exciting like “glittering star”. They take their job more seriously. The day is pretty good for the businessmen. The week looks more stirring and energetic on Wednesday. It is th...
Post a Comment
Read more