Ratio Analysis – Ratios are a mathematical tool that helps in defining the relationship between two figures. The analysis and interpretation of financial statements is carried out with the help of Ratio Analysis. The primary objective of ratio analysis is to help in understanding the performance of a company. Ratios reflect the strength and weakness of the company.
Objectives of Ratio Analysis
Following are the objectives of ratio analysis:
- Highlights the area of concern – When accounting ratios are compared with the ideal ratios prevailing in the industry, it brings to light the area which requires immediate attention of the management.
- Facilitates comparison – With the help of ratio analysis, comparisons of intra and inter company performances become easier.
- Evaluation of efficiency – They provide a detailed overview of the liquidity, solvency and profitability position of the business which in its entirety helps in evaluating the efficiency of the business.
- Forecasting and planning – One of the primary objective of ratio analysis is that they help in comparing the trend in the financials over the past years which aid the management in preparing future budgets and forecasts.
- Transparency to stakeholders – Ratio analysis helps the various stakeholders in measuring the operative efficiency of the company, thereby ensuring complete transparency.
- Better decision making – Analysis of various accounting ratios help the management in taking better and improved decisions.
- Simplicity – It converts complex financial figures which otherwise would require a professional to interpret them interpret into simpler data which is easily understandable by a layman.
Ratio Analysis is an indispensable tool to evaluate relationship among the various financial statement figures of a company. In the process, it provides important information regarding the profitability, solvency and liquidity position of the company which is one of the major objective of ratio analysis.