Introduction And Meaning Of Ratio Analysis
Ratio analysis is a quantitative technique of analyzing and evaluating financial data enclosed in the financial statements such as balance sheet, income statement, profit and loss account, cash flow statement etc. It converts complex financial data into simple ratios that helps to identify the financial state (profitability, solvency, liquidity, efficiency, business risk etc.) of the business firm. It provides significant information regarding the health of the business and helps the management to take proper steps to improve the performance if needed.
Importance Of Ratio Analysis
The main objectives or importance of ratio analysis can be pointed out as follows:
1. To Simplify The Financial Statements
Ratio analysis simplifies financial figures recorded in the financial statements into simple and meaningful ratios. So, it makes easy to understand the financial facts about the business without any confusion.
2. To Measure The Financial State
It analyzes the financial statements that helps to measure the financial state (profitability position, solvency position, liquidity position etc. ) of the business for a certain period of time. So, ratio analysis is important to reveal the financial position of the company.
3. To Evaluate The Efficiency
Different ratios are calculated to evaluate both managerial and operational efficiency of the firm. It helps to point out the deficiencies and misuse or mismanagement of resources in the business. So, it helps the management to improve the efficiency by taking effective steps.
4. To Compare The Performance
Another importance of ratio analysis is that it helps the company to compare its accounting ratios with other similar firms to find out the market position of the company. It helps the management to increase the efficiency and performance to achieve better results and improve the market position.
5. To Facilitate Planning And Forecasting
It analyzes and evaluates the past performance of the firm and provides important data and information about profitability, solvency, liquidity, efficiency etc. Management use these data for future planning, formulating policies and sales forecasting. These data are also used to make important financial decisions.
6. To Communicate The Information
Ratio analysis helps the users of accounting information such as management, employees, shareholders, lenders, government and public get accurate information regarding the financial health of the firm . So, it is important to communication the financial information to different users.
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7. To Assist Credit Decision
As we know that ratio analysis reveals actual financial condition of the company, creditors or investors can make lending decision on the basis of information provided by ratio analysis.
8. To Identify The Business Risk
It provides complete information about the financial state of the firm. It helps to understand the business risk of the company. So, management can take appropriate steps to minimize the risk.
