Ratio Analysis is a part of Financial Statement Analysis that is used to obtain a quick indication of a firm's financial performance in several key areas. Liquidity ratios Activity ratios Solvency ratios Profitability ratios

1. Ratio Analysis

2. Ratio Analysis is a part of
Financial Statement Analysis that
is used to obtain a quick indication
of a firm's financial performance in
several key areas.
1. Liquidity ratios
2. Activity ratios
3. Solvency ratios
4. Profitability ratios

3. Advantages and
Uses
of
Ratio Analysis

4. Analysis of Financial Statements : it enables to understand
financial position of the enterprise. Bankers, investors,
creditors, etc., all analyze financial statements by means of
ratios.
Simplifying Accounting Figures : it simplifies, summarizes
and systematizes a long array of accounting figures to make
them understandable. Its main contribution lies in
communicating precisely the interrelationships which exist
between various elements of financial statements.
Judging the Operating Efficiency of Business : ratios are
essential for understanding operating efficiency of an enterprise
and diagnosis of the financial health of an enterprise through
evaluating liquidity, solvency, profitability, etc. Such an
evaluation enables the management to assess financial
requirements and the capabilities of various business units.

5. Forecasting : It helps in business planning, forecasting
and future planning.
Locating the Weak Spots : ratios are of great
assistance in locating the weak spots in the business even
though the overall performance may be quite good.
Management can pay attention to the weakness and take
remedial action.
Inter-firm and Intra-firm Comparison : A firm
would like to compare its performance with that of other
firms and of industry in general (inter-firm comparison)
and the performance of different units belonging to the
same firm (intra-firm comparison). The accounting ratios
are the best tools to compare the various firms and
divisions of a firm.

6. Limitations
of
Ratio Analysis

7. Ignorance of Qualitative Aspect : The ratio analysis is
based on quantitative aspect. It totally ignores qualitative
aspect which is sometimes more important than quantitative
aspect.
Ignorance of Price Level Changes : Price level changes
make the comparison of figures difficult over a period of time.
Before any comparison is made, proper adjustments for price
level changes must be made.
No Single Concept : In order to calculate any ratio,
different firms may take different concepts for different
purposes. Some firms take profit before charging interest and
tax or profit before tax but after interest tax. This may lead to
different results.

8. Misleading Results if based on Incorrect Accounting Data :
Ratios are based on accounting data. They can be useful only
when they are based on reliable data. If the data are not reliable,
the ratio will be unreliable.
No Single Standard Ratio for Comparison : There is no single
standard ratio which is universally accepted and against which a
comparison can be made. Standards may differ from Industry to
industry.
Difficulties in Forecasting : Ratios are worked out on the basis
of past results. As such they do not reflect the present and future
position. It may not be desirable to use them for forecasting
future events.